Once Seen as a Panacea, Renewable Energy and Alternative Fuel Subsidies Have Become a Moral Hazard

Incentives for wind, solar and other renewable energy projects can create unforeseen business risks. Photo: ADB
Incentives for wind, solar and other renewable energy projects can create unforeseen business risks. Photo: ADB

By Kelly Hewitt

Tax and economic incentives for renewable energy and alternative fuel projects were once seen as key to attracting private investors to a country’s green energy plans. Increasingly, these subsidies – which can be revoked by governments as quickly as they were granted – are seen as risky and unpredictable if not rolled out carefully.

Tax and economic incentives for renewable energy and alternative fuels are favored by many governments seeking greener energy options. But these subsidies can create a moral hazard. Private sector investors often take on more risk and implement projects that would not be viable without the subsidies. Some may argue: “precisely – the point of tax and economic incentives are to mitigate risk associated with investments in new technology.” However, when such incentive schemes are not piloted; but instead, are rolled out full scale, moral hazards abound for private sector investors and government treasuries.

Investors need certainty. Yet, subsidies are based on public policy, not law, and can change at any moment. Change in government, change in strategy, change in budget all influence public policy. Acknowledging possible public policy change up front is a necessary part of an investor’s risk assessment. Assuming no change in policy creates the moral hazard of banking on the nonbankable.

  Navigating the uncertain waters of national green energy incentives.

Only two modes exist to mitigate policy change risk. The first is untenable – lobbying government to keep favorable policy alive. This mode is circular – mitigating the risk with reinstitution of the risk itself. The second and most tenable is to simply ensure, based on best estimates, that there is a return on investment that meets the minimum threshold requirement, without the subsidy. The latter represents liberal and free conventional market dealings – enabling market entry and retention where there is price, demand, and supply parity.

Public policy programs funded by government treasuries need to specify theory of change and desired impacts up front. Tax and economic incentives should be targeted and fit for their purpose to ensure actual effectiveness. Time horizons should be known and part of a thorough economic analysis. Also, timebound parameters applied under conventional financial analyses must be transparently known and tested. Government subsidies that are untargeted fail both economic and financial litmus tests. Desired impacts are not attained. While there may be some limited evidence of effectiveness, it is trumped by financial viability failure. Effectiveness is unsustainable.

  Across Asia, a rethinking of green energy subsidies and incentives

In several countries around the world, and in Asia, the moral hazard of tax and economic incentives can be seen demonstrating increased harm to investors and the government’s treasury. The subsidies start as a major driver of new renewable and alternative energy projects, but they are not targeted and time bound. As a result, countries are slow to remove the subsidies.

In some cases, such subsidies are removed without much notice in order to signal to investors that the renewable energy sector needs to become less dependent on subsidies. Such policy reversals aim to drive investors toward focusing more on scaling up technological and operational improvements than bringing down costs. This sounds much like the aim of the original subsidies.

But in some cases, green energy investors are discovering that without subsidies there’s no return on investment for over a decade. With subsidies, it might take only a few years to recoup costs.

In addition, renewable energy subsidies can strain a country’s treasury – more specifically, government institutionalized funding mechanisms designated to support renewable energy. Many countries have recently slashed subsidies for renewables and alternative fuels. Blanket subsidies are simply unsustainable. When not tailored to be fit for purpose or time bound, tax and economic incentives foster uncertainty and moral hazard. The result is harm to energy markets and government treasuries.

Tax incentives and subsidies can be effective tools for supporting green energy projects, but they need to be developed and managed carefully to make sure that they do not do more harm than good.