The era of subsidies for wind and solar may be ending far too soon

A cheaper future.
A cheaper future.
Image: Reuters/Amit Dave
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Last August, solar developers entered an auction to sell power into the Portuguese electricity grid. And many planned to lose money on every megawatt. One of the winning bidders, Spanish solar firm Enerland, offered to sell electricity for €11.14 (US$13.12) per megawatt-hour (MWh), one of the lowest auctioned electricity prices in history. One megawatt hour is slightly more than the average home in the US consumes per month

Enerland and other bidders are selling Portugal energy at prices as much as five-times lower (pdf) than the cost to generate it, estimates Bloomberg New Energy Finance (BNEF). But they are not throwing their money away. They’re betting the superior economics of solar power, and a coveted connection to the country’s crowded electricity grid, will cover any losses over the first 15 years (solar facilities are expected to last about 40 years). After that period, they can sell their power at prevailing market rates (now more than $50/Mwh), and pocket any difference as profits. Their grid connection never expires. 

This “quite remarkable” result, as João Galamba, Portugal’s secretary of state for energy put it, hints at a new future of renewables. Developers are willing to pay big money to sell cheap power into the grid. As renewable energy prices drop even further, says Jenny Chase, who leads solar analysis for BNEF, developers will find innovative ways to bring wholesale electricity prices even lower and return those savings to the grid.

“The Portuguese government expected to pay developers,” says Chase, “and instead developers are paying the grid.” That’s nothing less than a reversal of the economics of energy for the last half-century.

It happened again this February when Crown Estate Scotland, the monarchy’s property manager in the UK, held its first auction for offshore wind leases in a decade. Bids for offshore wind plots in the Irish sea came in far higher than expected, promising a windfall of as much as £9 billion ($12.5 billion) over 10 years. Among the highest bidders? Oil giant BP and its partner EnBW, a Germany utility, a sign that oil majors are now rushing into the sector. In response, British authorities have raised the maximum bid for offshore leases ten-fold to £100,000 per sq km, and called for a green sovereign wealth fund to reinvest its clean energy wealth, an investment vehicle similar to Norway’s oil-based fund.

Of course, not every auction will end up like those in Portugal or Scotland. But for the first time, renewables are the cheapest source of new electricity in much of the world. At least 80% of new electricity capacity is expected to come from renewables by 2030 with unsubsidized wind and solar starting to compete directly with fossil fuels. Governments can now imagine a world without subsidies for wind and solar power—and some are already slashing support. But if the world intends to reach net-zero emission by 2050, the target set by scientists on the Intergovernmental Panel on Climate Change (IPCC), the retreat is premature.

The world doles out $634 billion per year in direct energy subsidies, estimates International Renewable Energy Agency (IRENA). That is expected to decline as renewables bring down the costs of generating electricity over the next few decades. But the most likely scenario will not be the elimination of subsidies, but redirecting where the money goes. And no energy source receives more help today fossil fuels which collect about 70% of direct global energy subsidies, according to IRENA.

The true number may be far higher, says Daniel Kammen, a professor in the energy and resources group at the University of California, Berkeley. When accounting for indirect subsidies, fossil fuels enjoy $1.5 trillion to $5 trillion in support each year, argues Kammen. Most of it comes in the form of ignored health and environmental damage including an estimated 8.7 million deaths each year from cardiovascular disease, cancer, asthma and other disease worsened by air pollution. “Free market people will say we don’t need subsidies anymore,” says Kammen. “But those are fossil fuel apologists…we’re not at the point where we eliminate subsidies for renewables. We just need to wake up to the massive cost of fossil fuels.”

Renewables pay back the grid

In the 1990s, most electricity generation was still bought and sold by regulated utilities. Prices weren’t subject to competition; they were set by regulators. That changed when some state and national governments began requiring utilities to sell off generation, transmission, and distribution assets. Suddenly, competition transformed the energy market. Formerly publicly-owned power plants became rivals in a race to sell the cheapest, most reliable electricity.

Government-sponsored auctions revealed just how cheap renewables were becoming. Reverse auctions, in which developers bid to supply the lowest cost electricity, are now the favored model. At least 130 countries have started competitive auctions, and solicited astonishingly low prices. Since 2000, solar prices have fallen from around $750 per megawatt-hour to just $11 per MWh today—a 99% drop.  Much of that decline has happened in recent years, even as conventional fuel prices stay the same or rise slightly (coal, for example, remains around $100 per Mwh).  

“Competitive forces were allowed to work and dramatic price reductions followed as a result of moving down the technology and cost curves,” says Dan Shreve, the head of wind energy research at Wood Mackenzie, an  energy research firm. “All of these working together lowered the cost until the question in the market is, ‘Do you still require these subsidies?’”

That’s made it increasingly hard to justify subsidizing the cost of solar and wind directly. While the price of renewables used to be dominated by the value of government subsidies, today, it’s being driven by manufacturing and materials—silicon and steel, nuts and bolts. Capital markets, eager for reliable returns are piling in with favorable contracts and interest rates. In response, governments are phasing out renewable subsidies, and unsubsidized wind and solar plants are going up around the world.

Germany and Japan have ended direct subsidies, embracing auctions as a way to manage the growth (and ensure the stability) of renewables on the grid, according to Georgetown University. In Vietnam, an expiring tariff sparked a frenzy as solar developers connected 78 solar plants (up from four) in just a few months in the middle of 2019. The country has announced it will be switching to competitive auctions in 2021 and wind will follow in 2023. India, Mexico, Zambia, Madagascar, and Kazakhstan are following suit as well

Solar prices keep falling

Renewable projects owe their advantage to incurring most of their costs upfront during construction. Less than 25% of the total energy cost is for operation and maintenance, a share that’s falling fast. Fossil fuel generators are forever yoked to the cost of fuel. That’s made wind and solar, now priced well under $30 per Mwh, the world’s cheapest source of new electricity in most places around the world. 

And that’s just a preview of what’s to come. ”We are still in the early days of very, very cheap solar,” says Chase at BNEF. A combination of rapidly improving solar cells, more efficient construction, favorable government policies, and a sea of capital pouring into stable, attractive, and green investments is set to drive down costs further. That’s forced analysts to radically revise their forecasts for new installations, up 15-fold in recent decades, while cutting expected power-sector emissions in half, according to the consulting firm McKinsey. Analysts at the International Energy Agency have moved up their projections every year since 2005.

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Image: McKinsey

Endesa, a successful bidder in Portugal’s recent auction, sees the price wars intensifying. “Fierce competition has been a constant in the renewable industry for some years now, so it isn’t really something new,” said Endesa spokespeople Julia Llata Lavín and Iratxe Manchobas Fernández by email. Their company’s ultra-low Portugal bid is not yet commonplace, but securing a grid connection for low-cost renewables is now so valuable that developers like Endesa are now willing to return money utilities were prepared to pay for electricity. “The business rationale behind this was that the project would be profitable enough…. that we are able to give some contribution to the system,” they wrote.  

The global shift in subsidies 

Policy-makers are now grappling with a tectonic shift in the nature of energy markets. To manage this clean-energy transition, the nature of how to pay for a megawatt must change as well.

There’s still a huge gap between the world’s emission targets, and what the market can achieve on its own. To achieve a carbon-free grid by 2035, as US president Joe Biden has proposed, the US will need to add at least 70 gigawatts (GW) of wind and solar annually starting in 2025. Right now, estimates BNEF, the US is forecast to add an average of 43 GW per year. Only incentives, financing, and policy can make up that gap. “When we say subsidies are no longer required, what’s the end goal?” asks Shreve at Wood Mackenzie. “If the end goal is to rapidly decarbonize the grid, there may be a case for subsidies to remain in place.”

The next era of subsidies, forecasts IRENA, will shift to overhauling the grid to support higher penetration of zero-carbon fuel sources, and accelerate the retirement of existing fossil-powered plans before their normal lifespan. In a high renewables scenario, energy sector subsidies, now around 1% of global gross domestic product (GDP) would fall to 0.2% by 2050. Solar subsidies should shrink and disappear completely by 2050. More than $100  billion would be redirected to energy efficiency, heating, and cooling for industry and buildings. The fossil fuel sector would see 90% subsidies redirected to carbon dioxide capture and storage (CCS) for industrial applications (mostly the iron and steel, cement, and chemicals sector).  

“I describe this as a shift from technology subsidies—for solar or storage—to systems planning and infrastructure,” says Kammen. “It’s that kind of thoughtful step-by-step planning that changes the story.”

Getting there will be difficult. Not all fossil fuel subsidies are created equal. Politicians opposed to the shift will be quick to pounce on any failure, even when programs succeed (the US Department of Energy loan program supporting defunct solar cell manufacturer Solyndra ended up returning a profit to the US Treasury). Some subsidies, such as heating oil for the poor, are still essential to fight poverty. Figuring out the right mix of financial carrots and sticks will be politically perilous.

In the meantime, renewable prices will keep falling. In 2020, Abu Dhabi set the record for the cheapest solar price ever for a new solar project at the time: $13.50 cents/MWh. Recently, it fell under $10 per MWh for the first time, according to Kammen. At that price, it’s now becoming cheaper to build new solar farms than run existing coal plants. But powering a country on solar and wind, even at such low prices, means incentivizing enormous investments in transmission, storage, and grid balancing assets that have yet to be made. Not even experts agree on how to do that yet. “If you can do that,” says Kammen, “you can jump ahead of 90% of the world economists.”