Renewable energy in Spain is taking a beating 

Years of disastrous policies, coupled with the economic crisis, have recast renewable energy in Spain. Once touted as the embodiment of progress, wealth and sustainability, the industry is now seen as an unwanted and costly extravagance.

The policy turnaround started in 2010 but picked up momentum with a government decree in July aimed at closing a widening gap between the cost of electricity generation and what consumers pay – known as the tariff deficit.

The decree’s impact has all but erased public support for renewable power, raising alarms in the industry inside and outside Spain.

“We’ve gone from misery to ruin,” said Jaume Margarit, director of the Association of Renewable Energy Producers.

In essence, the decree aims to stop an unsustainable annual growth of the tariff deficit, which over the years has built up a cumulative debt of about €26 billion, or $35 billion. In an embarrassing admission, the government said last month that despite past consumer price increases for power and attempts at reform, the tariff deficit this year would reach €2.5 billion to €3 billion.

The call on the government’s coffers has soared as tax revenue has slumped because of the recession.

While the demand for power has plummeted nearly 6 percent since 2007 because of the slide in economic activity, the share of mandated renewable output has increased, crowding out cheaper coal and gas.

More than 27 percent of Spain’s power supply in 2012 came from renewable sources, excluding big hydroelectric generators, compared with around 13 percent in 2007 – one of the highest shares in the European Union.

The government’s bid to change course has all but assured legal battles with investors, and has triggered diplomatic pressure by the United States and the rest of Europe, as well as expressions of concern from the E.U. authorities.

Marlene Holzner, the European Commission’s energy spokeswoman, said: “The commission believes that careful attention must be paid to ensure that measures employed to eliminate the tariff deficit do not negatively affect the investment climate in Spain’s energy sector. In particular, ensuring a good climate for investment in renewable energy is a matter not only for Spain but for the European Union as a whole.”

The July decree, which has been rubber-stamped by the Spanish Parliament, laid out a framework for a thorough overhaul of electricity-sector regulations – to be completed by the end of the year with the publication by the government of detailed new rules.

The overall goal of ending the tariff deficit has broad support, including from the renewable energy industry, but nobody is happy with how the government has proposed to split the unavoidable economic pain.

Renewable energy, which for years was nourished and pampered – making Spain a global leader in the field – will bear by far the brunt of the reforms, both the government and industry experts said. In particular, proposals that would result in retroactive subsidy cuts have deeply rattled the sector.

The proposals have the potential to deliver long-term regulatory stability in the sector, said Tania Tsoneva, a credit analyst with Standard & Poor’s. “At this stage, however, it is still too early to conclude whether the reforms can and will be implemented,” she said.

The problem “essentially reflects a political unwillingness to pass all costs onto final customers,” said David Robinson, an economist in Madrid who specializes in energy policy and who is a senior research fellow in the Oxford Institute for Energy Studies.

“The regulatory system for renewables was badly designed and very expensive,” he said. But the proposed solution risks making some problems worse, he warned.

Mr. Robinson said the July decree “was designed to discourage further investment in renewable generation and reduce output from existing renewable facilities, mainly because of the substantial renewable capacity already on the system and the steep decline in electricity demand.

“The pendulum on renewable energy is swinging from heavily subsidizing mainly large centralized installations,” he continued, “to the other extreme of introducing barriers to the development of competition from decentralized renewable energy – which is the future of electricity systems worldwide.”

Furthermore, “this legislation introduces barriers to competition and will further complicate the aim of reducing CO2 emissions,” he said.

The Energy Ministry did not reply to numerous requests for comment, and complaints over the government’s lack of transparency in reforming the energy sector have been echoed by analysts, credit agencies and investors.

Spain is well placed to meet binding E.U. renewable energy targets. Around 16 percent of its primary energy – the energy that goes into producing electricity, transport fuels or heating – is supplied from renewable sources, according to the Association of Renewable Energy Producers, the main umbrella group for the industry here. The E.U. target is 20 percent by 2020.

Installed renewable generating capacity increased 75 percent since 2007, and that rate will probably slow abruptly starting next year because of the proposed changes.

The problem is that the tariff deficit has ballooned in tandem with rising renewable energy capacity, which has expanded by an average of nearly €5 billion a year since 2007.

By far the biggest increase in subsidy payments has gone to solar generators, which received about €1.6 billion in 2012 while contributing only 4 percent of power supply. Wind power generators received around €1.5 billion and produced 20 percent of power supply.

In addition to renewable energy generation subsidies, the tariff deficit is swelled by mismatched costs and revenues in power transportation and distribution and by accrued debt servicing costs, underwritten by the state, which have also spiked since 2007.

“We have always been in favor of fixing the system because it generates uncertainty,” said Mr. Margarit of the Spanish renewable association. “What we don’t agree with is that we carry most of the burden – because the deficit also comes from nuclear and hydroelectric generators, which still receive state aid even though their investments have long been amortized.”

Under the July 12 decree, wind and solar power producers will sell electricity on the open market like other generators and receive additional “fair” compensation based on their investment – which the government will determine through yet-to-be-announced mechanisms. That compensation will be linked to 10-year sovereign bonds, plus 300 basis points, implying an annual return currently of about 7.5 percent.

“The question is, what is fair?” said Ms. Tsoneva of Standard and Poor’s. “If the government goes too far, I wouldn’t be surprised to see some backlash.”

The government has said it will apply this new mechanism over an operational lifetime of 25 years, which in effect means that the new terms would be retroactive. Early investors who put money into developing the renewable energy sector over a decade ago could stop receiving subsidies all together from next year, though they were originally guaranteed profitable feed-in tariffs without any time limit.

Additionally, the decree reduces payments for electricity transmission and distribution; lowers payments for gas-fired power plants; reintroduces a social benefit for vulnerable consumers; caps the government’s share in eliminating the tariff deficit; increases the cost of hooking up to the grid and, most important, introduces an automatic tariff adjustment mechanism to avoid future deficits.

The government has not yet said how it will pay off the accrued €26 billion debt. Ultimately consumers and taxpayers will have to shoulder the cost, through power bills or government budgets.

Beyond the issues of fairness and funding, critics of the government’s policy shift express longer-term concerns.

Mr. Robinson, the economist, said: “The legislation is not dealing with the fundamental questions facing the Spanish and E.U. energy sector, in particular the inconsistencies between market-driven liberalization to drive down the cost of energy and the policy of promoting decarbonization through government-driven investment decisions.”

He said an example was draft legislation that would significantly raise the cost of expanding decentralized small power stations – known as distributed generation – mostly in the form of roof-top solar power, which the European Union wants more of and which has grown significantly in Northern Europe and the United States.

The reforms “significantly discourage investment in distributed generation, and in that sense they discourage innovation and the process of involving customers more directly in electricity markets,” Mr. Robinson said.

Additionally, critics say, the reforms could have unintended political and social fallout. Around 55,000 families have mortgaged their life savings and assets to invest in small solar farms in the countryside – with the guarantee of government-backed returns – in a bid to offset falling incomes from farming, said the National Association of Photovoltaic Energy Producers.

Often, their loans have been underwritten by relatives and friends who may also be at risk if the debts are not serviced. Banks meanwhile could end up repossessing yet more worthless assets and properties, worsening the already dire state of Spain’s financial system.

Until the specifics of the reforms are decided, much of the risk remains unclear. On the bright side, Spain’s economic collapse appears to have bottomed out: With economic recovery, power demand will rise and so will generators’ revenue. Yet, unless the government gets its policies right this time, that could just set the country up for another rise in the tariff deficit.

“At this point, we can’t conclusively say that the political and regulatory risks in Spain are eliminated,” Ms. Tsoneva said. “We think that the government is under significant fiscal pressure and our concern is whether it will continue to absorb the tariff deficit burden in the future. Even if the 2013 tariff deficit is successfully resolved, we believe uncertainty remains in the Spanish electricity system.”