‘Resource curse’ is a well-known phenomenon in the energy industry. When states discover a notable amount of oil, gas, or any kind of valuable natural resources, it is expected that this would lead to instant fortune, growth, and development, although this might not be the case for many resource-rich countries. Instead of providing prosperity and peace, these resources might bring along more conflicts and instability in the event of a mismanagement of wealth. Weak institutions, corruption, and poor governance are some of the reasons why prospective benefits of exploiting natural resources might morph into a curse in resource-rich countries.
Just like these conventional energy sources, renewable energy is also exposed to such a ‘curse’, albeit in a different form. This curse does not arise from the wealth acquired via the exploitation of natural resources, but rather it depends on the regulatory steps taken before or after the investments are made. This is mainly due to the lack of future planning while incentivizing renewable energy investments. Spain is a good example of this.
There are currently over 40 known investment treaty arbitration cases against Spain under the Energy Charter Treaty as a result of changes it made to its regulatory framework, at the end of which it could lose up to US$8 billion. While it was expecting a cleaner and more sustainable energy generation in accordance with the EU’s vision and targets, it now wrestles with tens of international investors before arbitral tribunals and billions of US dollars are at stake. So how Spain has come to this point?
In 1997, Spain enacted a new electricity sector law whose central objective was to liberalize the energy market and raise the share of renewable sources in its energy mix, especially of solar. Starting from this date up to 2007, Spain had tried to stimulate investments in its renewables sector but these attempts were doomed to failure for several reasons. Nevertheless, in 2007, Spain introduced a new mechanism with Royal Decree 661/2007 - the most generous incentive framework granted to renewables among all EU countries.
With this new regime, Spain provided solar energy producers with guaranteed rates (i.e. fixed feed-in tariffs: the above-market fee paid to renewable energy producers for the electricity injected into the network) for the lifetime of their renewable energy facilities. The National Energy Commission of Spain justified this approach by stating: “Economic incentives are fundamental for the development of the different technologies, if they are sufficient to create investments. In certain cases, different incentives leading to higher returns are justified in order to reach the established targets.” So, Spanish regulators had thought that it would be a good idea to offer higher fixed returns to investors through subsidies so that its renewable energy generation would increase to the anticipated levels. However, this method eventually proved wrong.
From 2007 onwards, thanks to these incentives, international energy investors rushed into Spain’s renewables sector and solar photovoltaic (PV) deployment levels witnessed a spike. While there were only 103 megawatts (MW) of annual capacity installation in 2006, it rose to 544 MW in 2007 and rocketed up to 2,708 MW in 2008.
One of the reasons for this spike was the decreasing initial investment costs as a result of falling solar PV panel prices and cheaper technology. This increase brought along an equivalent rise in tariff costs and in 2009 alone, Spain paid around €3 billion to subsidize renewable energy generation. Coupled with the financial crisis that emerged in 2008 and the decreasing electricity consumption that followed, the gap between the prices paid by final consumers and the subsidized sum paid to electricity generators –known as the ‘tariff deficit’- reached around €20 billion. To put it simply, the government was paying nearly €20 billion more to solar generators in the form of subsidies than it was collecting from consumers. The government then understood that this was an unsustainable concept.
The steps that Spain took after this were to modify its regulatory framework and retrieve some of the incentives it had granted earlier. It reduced tariff levels, put a cap on the operating hours eligible for payments, and introduced a new special tax for electricity generation, which affected the profitability of the existing projects and led to investor dissatisfaction. As a result, international investors resorted to investment arbitration against Spain.
The Spanish example clearly underlines the importance of having a well-thought-out regulation in place while offering incentives in the renewables sector. Potential advancements in technology and its effect on the costs must be taken into consideration while preparing the legal framework. To prevent a renewables curse, states should design a flexible mechanism instead of offering only long-term and fixed subsidies, while taking into account the next 25-30 years.