Investments in renewable energy and financial incentives

Investments in renewable energy and financial incentives

Financial incentives are the most popular measure suggested in policies to promote a change in the marketplace. The idea is that when actors are presented a sufficient profit for a change, they will act since they are expected to act rationally in their own economic interest. If necessary, governments have to provide additional incentives to facilitate the action. Governments have to buy down the difference in cost.

The incentive mechanisms could be considered as interventions supported by governments, bilateral and multilateral donors, that support the financial viability of renewable energy projects. They include two broad categories:

  1. Establishing an enabling environment conducive for private investments and profitable projects. This is usually done via market reforms, policies and regulatory frameworks, and has been the most adopted channel in developed countries. It is a very systematic way to address the issue, but typically requires mature governance and market structures.
  2. Creating public finance mechanisms to directly support specific projects and transform the close to viable projects into fully bankable projects. This has historically been the most adopted channel among donors and public finance funds. This approach is more ad-hoc, yet extremely pragmatic and it allows for quick wins/success stories, which can be held as examples for further investments.

Incentive design is highly dependent on local markets and consumer preferences, availability of public sector resources, and broader financial infrastructure. Importantly, by analyzing the local financial environment, the incentive can complement private sector finance initiatives that may be in plac. Because incentives are often specific to certain renewable energy and energy efficiency technology sizes, costs, and/or performance measures, robust technical and economic analysis of potential technologies can support successful incentive design.

Financial incentives can address various barriers to renewable energy and energy efficiency technology deployment. For instance, financial incentives can improve access to capital, reduce the burden of high upfront costs, lower financing costs, support creation of new markets, and address split incentives associated with energy-efficient technologies. In many markets, builders have little financial incentive to construct energy efficient buildings because the subsequent owners or tenants will pay the energy bills and reap any benefits from lower costs.

While tax incentives can be relatively simple and flexible instruments to support renewable energy and energy efficiency deployment, these incentives are only available for entities that have a tax burden. Common types of tax incentives are described below.

  • Corporate income tax incentives can be tax deductions or credits for on-site use of renewable energy or energy efficiency technologies or for large-scale renewable energy that is fed into the grid. In relation to renewable energy, corporate investment tax credits are based on initial cost of renewable energy systems, while production tax credits are based on actual energy produced. Therefore, production tax credits can be more effective in incentivizing maximization of energy production over the long term. However, other tax incentives may also be required to address potentially high upfront investment costs.
  • Personal income tax incentives are tax deductions or credits, normally based on investment or cost of a renewable energy system or energy efficiency technology.
  • Property tax incentives are utilized when renewable energy systems (distributed or utility-scale) or energy efficiency technologies are implemented to improve a property. These incentives reduce the level of taxes associated with the property improvements.
  • Value added tax (VAT) incentives lessen or eliminate VAT taxes for energy efficiency and renewable energy technologies (applied at both the distributed and utility-scale levels) for individuals and/or businesses.
  • Accelerated depreciation quickens renewable energy fixed asset depreciation and thus, through reducing taxable income, defers tax liability in the early stages of renewable energy project development.

In addition to tax measures, rebates, grants, and performance-based incentives can be designed to support renewable energy and energy efficiency action and technology deployment. Rebates, grants, and performance-based incentives provide a direct cash incentive to support energy efficiency and renewable energy and typically do not require repayment. Performance-based incentives

Selected examples of direct cash incentive programs are described below.

  • Rebates are typically applied to discrete purchases such as appliances and vehicle purchases, and are often provided after purchase and/or installation. They are often provided by utilities and funded through utility customer payments. Rebates are commonly used for energy efficiency home improvement and construction, energy efficiency appliances, energy efficiency vehicles, and on-site renewable energy systems.
  • Grants can be provided before a technology is installed (e.g., for research, development, and demonstration; business development; or feasibility studies) or after a system is fully operational. Grants commonly fund research and development, feasibility studies, system demonstration, installation, and operation, and/or business development. Through hybrid approaches, grants can also be combined with subsidized loans to support renewable energy and energy efficiency deployment.
  • Performance-based incentives are provided based on actual performance of an installed technology (e.g., cents per kilowatt-hour payment). Hybrid rebate and performance-based incentives can also support upfront investment and ongoing performance of renewable energy and energy efficiency systems.

Loan programs, guarantees, and credit enhancements can also be designed in various ways to support renewable energy and energy efficiency technology deployment. Selected examples of renewable energy and energy efficiency loan incentive programs and products are presented below.

  • Subsidized traditional revolving loans reduce loan interest rates for energy efficiency and renewable energy technologies by providing a loan loss reserve fund or similar mechanism that serves as a form of insurance in the event of loan failure. Successful revolving loan funds are designed in such a way that the revenue from repaid loans (i.e., interest payments) covers net losses to the fund, and thus the fund can issue loans in perpetuity).
  • Mortgage-related loan programs include property-assessed programs that provide funding for small-scale renewable energy systems and upfront energy efficiency improvements on a property that are paid back over time by commercial and residential property owners. Mortgage loans for energy efficient homes can also incorporate special loan terms (e.g., allowing higher debt to income and loan to value ratios) because the mortgages assume future energy savings for the homeowner.
  • Credit enhancements reduce credit risk associated with renewable energy and energy efficiency investments through various mechanisms such as interest rate buy-downs and reserve accounts. Loan guarantees are common credit enhancement incentives that support reduced loan interest rates by providing assurance to a lender that loans will be fully or partially repaid in the event of borrower default.
  • Green banks can provide loans and other incentives through public-private partnerships and innovative financing approaches, reducing the need for ongoing public funding. Green banks can bundle financial incentives to support various phases or aspects of energy efficiency and renewable energy deployment (e.g., grants could be used to support renewable energy business model development and loans could be used to support renewable energy technology installation and initial operation).

For renewable energy investment, all these incentives are well for promoting and achieving good development of the energy sector and overall economy, while creating especially business opportunities and climate investment

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