Briefing: Energy subsidies

What are energy subsidies and how long are they needed?

Meeting energy demands

When it comes to ensuring that the country’s demands for energy are met, the UK government, like many others, has quite the balancing act to pull off.

Not only does it need to find sustainable and affordable ways to keep the lights on, it has to do so while meeting ambitious targets for reducing the greenhouse gas emissions that contribute to global warming set by the Kyoto Protocol.

That means investing in a mix of both renewable and traditional energy sources.

When it comes to meeting carbon reduction targets, clean energy generated from renewable sources (solar, wind, hydro, tidal and geothermal) is clearly preferable to energy derived from fossil fuels. Fossil fuels are finite resources. While new pockets of coal, oil and natural gas are still being discovered, or made accessible by new and more affordable extraction methods (many of which are polluting in themselves), they will eventually run out. We may not know when exactly, but it’s a scenario that needs to be planned for.

But with significant investment still needed to establish comparable infrastructure, supply chains and network connections, the cost of generating renewable energy is currently higher than traditional energy sources, making it difficult for renewable energy companies to compete in energy markets.

And that’s where energy subsidies come in.

Levelling the playing field

There is no single internationally agreed definition of what constitutes an energy subsidy, but the International Energy Agency defines them as:

“Any government action that lowers the cost of energy production, raises the price received by the energy producers or lowers the price paid by the energy consumers”.

In general, governments use energy subsidies to support new, often low-carbon technologies but some are used to support fossil-fuel generators, often to secure supply at consistent prices. Typically, they are funded by extra fees added to consumers’ energy bills.

Subsidies are rarely permanent – instead they’re put in place to temporarily boost competition in local markets as a means to ensure affordable energy for consumers and to drive research and development into new, cleaner technologies.

When is the right time to stop?

But when is the right time to stop them? This can be a headache in itself for governments.

Let’s take the UK as an example, where subsidies were introduced to attract greater investment in renewable energy technology to bring the cost of production in line with non-subsidised energy sources. Theoretically, subsidies would end when the playing field is deemed level, with all energy generators operating under equitable tax incentives, regulations and trade restrictions – all conditions that can be hard to accurately gauge.

Investors need clear signals, well in advance of impending changes to subsidy frameworks to give them confidence to continue providing financial backing. As such, subsidies would ideally be introduced with clear timelines for being phased out, linked to the rate of uptake of the technology being subsidised.

The market needs clear signals

However, in stark contrast, earlier this year the UK government announced that it would be ending subsidies for onshore wind farms 12 months earlier than planned. They also announced that they planned to consult on ending subsidies for solar farms and remove some subsidies for biomass conversions.

While this doesn’t spell disaster for the UK’s renewables sector, it will certainly have an impact, no doubt leading to a reduction in investor confidence.

Renewable energy is on the right track

However, the cost of generating renewable energy, especially onshore wind and solar, is coming down. Combined with the likelihood of a new international carbon reduction agreement being struck in Paris in December 2015, investment in fossil fuels is starting to look less attractive.

These two factors provide a glimmer of hope and should bring continued support for renewables.

But the most successful route to an energy mix less reliant on fossil fuels must include an approach to subsidies that offers much clearer advance signals to investors linked to a coherent vision from the government for a low-carbon future.

Expert advice

RSA insured the world's first offshore wind farm in 1991 and we've continued to lead renewable energy insurance industry ever since.

To speak to one of our renewable energy experts, email globalspecialtylines@gcc.rsagroup.com or telephone +44 (0) 20 7111 7000.

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Read about our five-year corporate responsibility strategy which includes targets linked to moving toward a low-carbon economy.