Insights

29/09/2017

Renewable energy subsidy reform

The Ministry of Economic Affairs and Employment has published a draft government proposal for a new subsidy system, 'premium scheme', for promoting electricity production from renewables by means of inviting tenders. 

The premium scheme would be intended as a transition period solution between the feed-in tariff system and future development needs of renewable energy sources on market conditions. The objective is to invite tenders for a total of 2 TWh of annual electricity production. The Ministry has circulated the proposal with comments due on 4 October 2017.

THE FOUNDATION OF THE PREMIUM SCHEME

According to the draft proposal, the key elements of the new premium scheme are:

  • availability for renewable sources: wind, solar, wave, wood fuel, and biogas power are included;
  • descending auction: also known as Dutch auction, to decide which renewables projects will receive premiums for electricity produced – cost efficiency is key;
  • pay-as-bid: winning bidders receive premiums in accordance with their bids when electricity market price is equal to or lower than EUR 30/MWh, and a reduced premium when market price is higher than EUR 30/MWh. The formula for calculating the reduced premium is: Bid premium – (Electricity market price – 30 €/MWh);
  • targeted electric capacity: capacity is subject to each auction round, and will be determined annually by the government. The government has expressed intentions of targeting 2 TWh of additional electricity production from renewables overall (all auction rounds together); 
  • capped subsidy: the subsidy is capped to annual average electricity production over three four-year periods or maximum twelve years, unless the production cap is reached earlier;
  • strict legal criteria: participation in the auction system includes similar criteria known from the feed-in tariff system with several additional requirements; and 
  • sanctions apply: for those who fail to perform in accordance with their winning bid - make sure to carefully assess fulfilment of the criteria!

STRICT TIMELINES APPLY – ARE THEY FLEXIBLE?

The bidders are required to determine in connection with their bid the first tariff period (i.e. calendar quarter) as of which the right to receive premium should commence. The first tariff period must be at the latest the following calendar quarter after three years have lapsed from the acceptance date. 

Moreover, the entire project should be completed within five years as of the acceptance date. Unless the project is at least partially connected to the grid within the aforementioned three-year period or fully completed within the aforementioned five-year period, the acceptance decision will expire. The Finnish Wind Power Association has questioned if the time limitations should be shorter. 

In the current proposal it is unclear if it will be possible to change afterwards the first tariff period determined in the bid. The draft government bill remains silent in this respect and does not provide guidance whether advancing or postponing the first tariff period is later allowed. The Finnish Wind Power Association has also acknowledged this potential issue and presented inquiries in this respect with the Ministry of Economic Affairs and Employment.  

The outcome would be unreasonable if the provision would allow to advance the first tariff period but prohibit the postponing thereof thus exposing the energy producer to sanctions only in case of postponing. If that would be the case, it would always be advisable to set the first tariff quarter to the latest possible moment, and in case of large wind power projects comprising of several turbines, even to split the project in smaller units, to minimise the risk of sanctions. 

A fair solution would be to enable the energy producer to freely change the first tariff quarter within the three-year period depending on the progress of the construction works. This would improve the equal treatment of large and small wind power projects as the large projects take more time to construct and are subject to higher risk of delay in construction works. 

In particular large power plant projects require flexibility as a number of reasons can cause changes to the estimated construction schedule. If the proposed premium scheme would not allow changing the first tariff period (within the three-year maximum period) after submitting the bid, an optimal tariff period may not be necessarily achieved which may in turn lead to financing issues. If changing of the first tariff period would not be allowed in the proposed premium scheme, one should be very cautious about being too optimistic with the construction schedule, also considering strict sanctions attached to underperformance. 

SEVERE SANCTIONS – OVERSTATEMENT?

According to the proposed premium scheme, if the bidder does not produce on average at least 75% of the offered annual electricity production within the first four-year period, or at least 80% thereof within the second or third four-year period, the bidder must compensate the underproduction to the Energy Authority. The underproduction compensation is calculated as the shortfall of the produced annual average electricity production multiplied with the quoted premium.

In addition, if the power plant is not entirely connected to the grid within the three-year period, the Energy Authority will withhold a share of the construction period guarantee pro rata compared to the amount of capacity not connected. The construction period guarantee is proposed to be EUR 16/MWh. In such case, the bidder will also not receive full amount of premiums as less electricity is being produced. 

REQUIREMENTS FOR PROJECT SIZE AND PARTIAL ACCEPTANCE

To participate in the auction, a power plant project must be of a specific size. The draft proposal sets limits to both minimum and maximum power output levels, the maximum being the capacity targeted by the auction. Projects exceeding the capacity auctioned are excluded from the auction. If a project fits the premium scheme only partially due to capacity already reserved by other bids, or if two or more projects are tied in their bids, such projects can be accepted to the system partially provided that they have both consented to partial acceptance to the premium scheme in their bids. 

There is potentially a significant risk involved for a project to consent in advance to partial acceptance to the premium scheme. Presumably most bids are calculated on the assumption that the entire, or most, of the capacity will be finally accepted to the premium scheme in order for the bid to be as cost-effective as possible. If at the end only a portion of the capacity is accepted to the premium scheme, the project may not be economically viable with the quoted premium. 

It is problematic requiring the bidders to consent to partial acceptance beforehand when it is not known how much capacity will be left for the partial acceptance. A more reasonable approach would be to ask the bidders if they consent to partial acceptance afterwards once it is known how much capacity will be left.

Requirements relating to the project size may result in a need to rearrange the project structure, especially in case of large wind farms and, to the extent possible, projects that are partially accepted to the premium scheme. Such rearrangements may take time and should be initiated as soon as possible. 

INVESTMENT DECISION

A binding decision about ordering the required equipment or commencing construction would exclude the energy producer from the premium scheme. The wording of the draft government bill is not very successful in this respect as project companies do not necessarily make any formal decisions on when to commence construction or to order the required equipment. 

ARE YOU READY-TO-BUILD?

The proposed premium scheme requires that in order to participate in the auction the land use planning and the construction permit must be legally valid and binding. 

As there are typically various different permits required for a renewables project, the formulation of the proposed provision is not optimal as the mentioned permits do not necessarily mean that the project is ready-to-build. The important question is whether the construction can be commenced without undue delay after having obtained acceptance decision. However, the proposed severe sanctions attached to non-performance or underperformance are likely to ensure that only realistic projects will finally participate in the auctions.

AMENDMENTS TO THE REAL ESTATE TAX REGULATION ON THE WAY – A THREAT TO WIND POWER?

It should also be noted that a government proposal on the amendment of Section 14 in the Finnish Real Estate Tax Act has been issued on 31 August 2017. The proposed amendments concern the taxation of wind power plants. 

Pursuant to the current legislation, wind farms with a nominal capacity of maximum 10 MVA are subject to the general real estate tax rate of between 0.93% and 1.80%, as decided by a municipality. In accordance with the proposed Act, the 10 MVA threshold would, however, apply to the aggregate nominal capacity of all turbines connected to the grid through the same connection point. 

The proposed amendments would affect wind farms that are currently subject to the general real estate tax, but that have an aggregate nominal capacity exceeding the 10 MVA threshold provided for in the Act. Wind farms exceeding the threshold could therefore be subject to a separate real estate tax rate of 3.10%, at its maximum.

The proposed Act has been sent to the Finance Committee for its committee report and is subject to the Finnish Parliament's approval. The rules are intended to be applicable as of fiscal year 2018. The adoption of the aforementioned amendments would undoubtedly weaken the wind power plants' competitiveness in the auction. 

WHAT NEXT?

If approved by the Parliament during autumn 2017, the new premium scheme would enter into force in 2018. 

Krogerus' Energy and Infrastructure team will continue monitoring the progress of the proposed new legislative amendments.