There has been a lot of talk in the U.S. about the collapse of the Spanish solar market this year, commonly held to have been a solar bubble. However, few U.S. commentators seem to understand the Spanish market enough to go beyond the standard quip that the Spanish were simply throwing too much money at solar — and that feed-in rates were the culprit. A closer look reveals what Spain’s real problems were, and where those problems could happen in the U.S. as well.

With feed-in rates, the extra money required to make renewables profitable generally does not come from a governmental budget; rather, costs are passed on to consumers in the form of higher retail electricity rates. But the particularities of the Spanish electricity market prevented these extra costs from being passed on. At the beginning of each year, the Spanish government sets retail power rates. If, say, the price of natural gas skyrockets that year, the Spanish government later reimburses power providers and grid operators to cover the difference.

In this way, electricity rates are kept artificially low, with part of the cost being covered by taxpayers. And since just about every country, including Spain, is running a budget deficit, the Spanish are having future generations subsidize current electricity consumption. The Spanish are well aware of the problem. As Industry Minister Miguel Sebastián put it, the practice is “irrational and untenable.” Spain has responded by starting to phase out the entire system. By 2013, it is to be done away with altogether.

This “energy deficit” has risen to 14 billion euros since 2000 (around 300 euros per Spaniard), and renewables were not the only cause, with energy prices rising in general over the past decade, but there can be no doubt that the spike in solar in 2007 and 2008, when the solar market grew by a hundred percent each year, took Spanish budget planners by surprise. As the decree that revised the solar rates put it, “Energy sources under this special regime constitute a risk for the system’s sustainability because of their effects on power prices.”

The changes include not only a ceiling on the amount of solar that can be installed, but also the addition of a registry, which will also cover installed wind capacity. Up to now, the government has not kept close tabs on how much is actually put in the ground; that task was largely left up to industry associations. Now, you have to enter your project in the registry so the government can tell you where you are in the line — whether you can connect your project to the grid this year or not and get this or that rate. For instance, the various regions of Spain are quite keen on expanding renewables, and it turned out that they cumulatively had a target for wind power of around 40 gigawatts by 2010. But Madrid has specified a national target of only 20,155 MW for that year. The registry will be one way that the central government will be able to rein in the regions in terms of wind power.

Similarities with the U.S.

Although Spain’s situation is unique, there are a number of overlapping spots. Most saliently, renewables policies in the U.S. often specify either that the investments in renewables must not raise the retail rate or not by more than a certain level. Also, though Americans believe they are living in a freer market than Europeans do, utilities and governmental regulatory bodies also work out retail electricity prices in the U.S. American utilities, whether private or public, are considered “natural monopolies.” As such, the government regulates them to prevent price gouging, but in return the utilities are guaranteed a certain profit margin. Call it price fixing.

So while critics of feed-in rates do not seem to like the idea of the government setting prices, we see that governmental pricing did not start with subsidies for renewables. It was there all along both in Spain and the U.S. (but not Germany).

We also clearly see that feed-in rates were not the sole cause of the problem in Spain. Rather, Spain attempted to combine feet-in rates with inflexible, a priori government pricing of retail rates.

What to do?

So how do we stop the U.S. from repeating Spain’s mistakes? To my mind, there are two different ways of addressing this question: the first assumes that feed-in rates will be implemented; the second, that they won’t be.

Assuming that feed-in rates are adopted, costs would have to be passed on to consumers — today’s consumers, not tomorrow’s. And if you want to keep the retail rate in check, you can do what Spain failed to do, but other countries with feed-in rates have done: have the rates decrease not only every one or two years, but also in volume increments.

We all know the policy from car warranties: five years or 50,000 miles, whichever comes first. Assuming that you want the rate paid for newly installed solar arrays to drop by, say, five percent each year, you could also have that rates kick in earlier if, say, 500 megawatts had been installed. If you are paying 30 cents per kilowatt-hour for solar, you can get a rough estimate of how much 500 megawatts in good locations are going to cost you. Weather conditions will vary, but your estimate will be accurate +/- around 10 percent for a given year.

You can then also do what Spain has now done and further subdivide those 500 megawatts if you want to ensure that a small number of projects do not take up the whole pie. Go ahead, set aside a couple of hundred megawatts for the countless roofs of Joe the Plumber and his friends.

When companies and homeowners register their systems, they can be told up front where they are on the list. They can be given a window within which they have to connect to the grid, and if they cannot complete their projects on time, those further down in the list will be happy to learn that they will be trading places and getting a slightly higher rate. Planning is thus not only still possible under such a scheme; the surprises it produces are also mostly pleasant.

If you don’t want to have feed-in rates, of course, you can simply set aside a budget for solar, wind, and whatever. When that budget is full, you can decide whether you want to devote more money to renewables.

You will then certainly not only prevent a bubble from occurring, but in all likelihood also fail to meet whatever ceiling you set for yourself. Ask any solar advocate in the U.S., and they will tell you that there is a tremendous amount in the pipeline. So why is it not going in the ground? What is holding up solar in the U.S.? What do our policies fail to do that feed-in rates get right?

While Americans are understandably excited about a couple of high-visibility projects for hundreds of megawatts of solar, the Germans I talk to fail to understand what the excitement is about. “We are going to put up a couple of thousand megawatts in 2009, and a large part of that is loads of rooftop systems with just a couple of dozen panels each,” one German industry insider told me recently.

So yes, the U.S. does run the risk of repeating Spain’s mistakes if feed-in rates are implemented. The conclusion does not, however, have to be that feed-in rates are dangerous. Instead, we need to look at the entire energy policy context and see where Spain and the U.S. are similar — and remember that the policy of feed-in rates was not itself thrown out in Spain. Only the rates were adjusted, and even that only affected solar. Spain still has feed-in rates.