What it means
Electricity prices move constantly, which makes it hard to raise finance for a project whose only revenue is selling power. A feed-in tariff removes that uncertainty by fixing the price per kilowatt hour for the life of the contract and obliging the grid operator or utility to buy the output.
The generator knows its revenue almost exactly before a single panel goes on a roof. There are two broad designs.
Under a gross tariff every unit generated is paid at the tariff rate, while under a net tariff only the surplus exported after on-site consumption is paid, with the rest simply reducing the owner's own electricity bill. For a business the tariff turns a capital project into something close to a bond.
Finance directors evaluate it with the same tools they use for any long-lived asset: capital cost, expected annual output, payback period and the return over the contract term. Tariff rates are usually set above the wholesale price of electricity and are stepped down over time as installation costs fall, a mechanism generally called degression.
Rates also vary by technology and by installation size, because a rooftop array and a wind farm have very different cost structures. The main risks are political rather than technical.
Governments have closed or cut schemes at short notice, and projects signed under one set of rules have occasionally found the terms revised, so lenders look closely at how legally binding the tariff commitment actually is.
In practice
Real-world examples.
Example
A family-owned dairy installs an anaerobic digester that turns slurry into electricity and secures a feed-in tariff of $0.11 per kWh for 20 years. The guaranteed revenue of 800,000 kWh x $0.11 = $88,000 a year persuades its bank to lend $630,000, or 70% of the $900,000 build cost.
Example
A property developer prices rooftop solar into the appraisal for a 40-flat scheme because a net feed-in tariff turns the panels from a pure cost into a small income line. The projected $6,000 a year of export revenue lifts the valuation of the block by more than the panels cost to fit.
Example
A manufacturer with a 2 MW wind turbine finds the tariff scheme closed to new entrants a year after commissioning the machine. Its own revenue is unaffected because the contract was already signed, but a planned second turbine is shelved when the replacement scheme offers a market-linked price instead of a fixed one.
Formula
Calculation
Annual tariff revenue = annual generation in kWh x tariff rate per kWh. Simple payback period = capital cost / annual revenue.
A logistics company installs a 250 kW rooftop solar array on its distribution centre at a capital cost of $420,000. The array is expected to generate 300,000 kWh a year and qualifies for a feed-in tariff of $0.14 per kWh under a 15-year contract.
Annual revenue = 300,000 x $0.14 = $42,000
Simple payback = $420,000 / $42,000 = 10 years
Total contract revenue = $42,000 x 15 = $630,000
Net gain across the contract = $630,000 - $420,000 = $210,000
The project repays its capital cost during year ten and delivers $210,000 above that cost by the end of the tariff period, before counting anything the array is still generating once the contract has expired.Case study
Seen in the real world.
Bramble Hill Brewery is a fictional mid-sized brewery used here to illustrate how a feed-in tariff changes a capital decision. Its board had rejected a solar proposal twice, because electricity savings alone produced a payback of about 14 years and the finance director would not approve anything beyond ten.
A revised proposal applied a gross feed-in tariff of $0.13 per kWh to the full 260,000 kWh the array was expected to generate, worth 260,000 x $0.13 = $33,800 a year against a capital cost of $338,000. That brought the payback to exactly $338,000 / $33,800 = 10 years, and across the 15-year contract the tariff would produce $33,800 x 15 = $507,000 against the $338,000 spent.
The board approved it with one condition that turned out to matter more than the arithmetic: the finance director insisted on written confirmation that the tariff rate was locked at the accreditation date rather than at the grid connection date. A four-month connection delay would otherwise have dropped the project into the next degression step, and the illustrative lesson is that in tariff-backed projects the paperwork dates are worth as much as the engineering.
Watch out
Common mistakes.
- Assuming the tariff rate is paid on every unit generated regardless of the scheme design. Under a net tariff only exported surplus earns the rate, which can halve the revenue in a building that uses most of its own output.
- Modelling the project on the equipment supplier's optimistic generation estimate. Shading, panel degradation and downtime routinely take real output below the brochure figure, and the payback stretches accordingly.
- Treating the tariff as risk-free income. The counterparty still has to pay, schemes have been amended in the past, and the contract wording on rate lock-in is worth reading closely.
Questions
People also ask.
How is a feed-in tariff different from a power purchase agreement?
A feed-in tariff is set by government policy and applies to all qualifying generators, while a power purchase agreement is a privately negotiated contract with a specific buyer.
Does a feed-in tariff mean free electricity for the site?
Not under a gross tariff, where the site is paid for everything it generates and continues to buy what it consumes; under a net tariff the on-site consumption reduces the bill directly.
What happens when the tariff contract ends?
The equipment usually keeps producing for years afterwards, but the output is then sold at market prices or used on site, so the economics have to be re-tested at that point.
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