Table of Contents
Introduction
Feed in tariffs and feed in premiums are two of the most widely used policy tools to support renewable electricity. Both give renewable generators a predictable income, but they do so in different ways and create different incentives. This chapter explains how each instrument works, why governments use them, and what their main advantages and challenges are, especially from the perspective of beginners who want to understand how policy shapes renewable energy markets.
Basic Idea Of Feed In Tariffs
A feed in tariff, often shortened to FIT, is a policy where the government guarantees a fixed price for every unit of electricity produced from eligible renewable sources and fed into the grid. This guaranteed price is usually higher than the normal wholesale electricity price. The payment is normally offered for a long period, such as 15 to 20 years, and is written into law or regulation.
The amount paid is usually defined per kilowatt hour, for example in cents per kWh. A small solar rooftop system, a wind turbine, or a biogas plant that is approved under a feed in tariff scheme can sell all the electricity it produces to the grid operator at this fixed price, regardless of what happens to market prices. This creates very high revenue certainty.
The core principle of a feed in tariff is that the grid operator has a legal obligation to connect eligible renewable projects and to purchase all the electricity they generate at the fixed tariff. This is often called purchase obligation and priority dispatch. The details of grid access and dispatch are addressed in another chapter, so here the important point is that feed in tariffs combine guaranteed price with guaranteed off take.
How Feed In Tariffs Are Structured
Feed in tariff schemes typically use several design elements to steer investment. One common element is technology differentiation, which means that each renewable technology can receive a different tariff level. For example, solar photovoltaics, onshore wind, offshore wind, biogas, and small hydropower might each have their own tariff rate. Very often, there is further differentiation within each technology by size or application, such as higher tariffs for small rooftop systems compared to large ground mounted solar farms.
Another important feature is the tariff duration. The guaranteed price is fixed at the time the project is approved and usually remains constant, sometimes adjusted with inflation, over a set support period. After this period ends, the plant must sell its electricity at normal market prices or under any new policy that might be in place.
Many feed in tariff schemes include tariff degression. This means that for new projects the tariff level is gradually lowered over time, usually according to a pre announced schedule, for example by a fixed percentage each year. Degression reflects expected cost reductions in renewable technologies and aims to avoid overcompensation. Older projects keep the tariff they were initially offered, while only new projects receive the lower level.
Funding for the feed in tariff can come from different sources. In many countries, the cost difference between the tariff and the market price is passed on to electricity consumers through a surcharge on their bills. In others, part or all of the cost may be covered by the state budget. The exact cost recovery method has strong political and social implications, which are considered in other chapters dealing with equity and affordability.
Why Governments Use Feed In Tariffs
Feed in tariffs became popular because they are simple to understand and give investors confidence. Someone who wants to install a small solar system on their home or farm does not need to understand complex auction rules or wholesale markets. They only need to know the tariff rate and the duration of support. This clarity has been very effective in triggering rapid growth of renewables, especially in early market stages.
For banks and other financiers, feed in tariffs reduce risk because revenue is both predictable and legally guaranteed, as long as the plant operates as expected. This lowers the cost of capital and can make more projects financially viable. For policymakers, feed in tariffs allow targeted support for specific technologies, such as higher tariffs for emerging options that are still more expensive.
At the same time, feed in tariffs offer a relatively direct way to promote small scale and community projects. Households, cooperatives, and farmers can participate without competing in large tenders or trading in wholesale markets. This can increase public acceptance and political support for renewable energy expansion.
Risks And Challenges Of Feed In Tariffs
Despite their simplicity and success in expanding renewable capacity, feed in tariffs also come with important challenges. If tariffs are set too high compared to actual technology costs, investors can gain very large profits at the expense of electricity consumers or taxpayers. This risk is greater when technology costs fall quickly, because a tariff that seemed reasonable at the start can become excessive a few years later.
Another difficulty is controlling the volume of new installations. If many projects rush to take advantage of attractive tariffs, total support costs can rise rapidly. Some governments have experienced unexpected surges in solar capacity, which forced abrupt policy changes and retroactive cuts that damaged investor confidence. To address this, some schemes introduce capacity caps or reduce tariffs automatically once certain installation thresholds are reached.
Feed in tariffs also tend to separate renewable producers from short term price signals in the electricity market. Because revenue is fixed per kWh, there is little incentive to produce when electricity is most valuable or to respond to grid conditions. In systems with low shares of renewables this may not be a major issue, but as renewables grow, the lack of market integration can create challenges. Concerns about cost control and system integration have led many countries to shift from pure feed in tariffs toward more market oriented instruments.
Feed In Premiums: Concept And Logic
Feed in premiums were developed as an alternative that keeps support for renewables but links producers more closely to electricity markets. Instead of receiving a fixed tariff per kWh, the generator sells its electricity on the wholesale market and receives the market price. On top of this market revenue, the government pays a premium. The total income is therefore the sum of the market price and the premium.
The key idea is that the producer has to participate in the market like any other generator. The premium is a separate payment that improves project economics but does not fully shield the generator from price variation. As a result, feed in premiums preserve some exposure to market signals and, in many designs, encourage more efficient integration of renewables into the power system.
There are two main forms of feed in premiums. In a fixed premium scheme, the premium payment per kWh is constant and does not depend on the market price. In a sliding or variable premium scheme, the premium is adjusted to keep the total revenue around a target level. These two variants create different risk profiles and behaviors.
Fixed Feed In Premiums
Under a fixed premium, the government specifies a constant amount per kWh that will be paid in addition to whatever price the generator receives from the market. If the premium is $p$ and the market price is $P_{market}$, then the total price received by the generator is:
$$
P_{total} = P_{market} + p
$$
For example, if the wholesale price is 40 units per MWh and the premium is 30 units per MWh, the generator receives a total of 70 units per MWh. If the wholesale price rises to 60 units, the total becomes 90 units per MWh. The premium does not change, so when market prices are high, the generator gains more revenue.
A fixed premium scheme leaves the generator fully exposed to market price risk. When prices fall, the total income can drop to levels that might be insufficient to cover costs. When prices are high, the generator benefits. Policymakers may choose this design when they want to encourage renewable generators to respond to price signals, for example by providing more accurate forecasts and by participating actively in balancing markets.
Sliding Or Variable Feed In Premiums
A sliding or variable feed in premium aims to achieve a stable total remuneration level while still requiring the generator to sell in the market. In this scheme, the regulator defines a reference or strike price, often called $P_{ref}$, which represents the desired average price per kWh that the renewable generator should receive. The premium is then calculated as the difference between this reference price and a reference market price.
If $P_{market}$ is a chosen measure of the average market price over a certain period, then the premium per kWh can be written as:
$$
Premium = P_{ref} - P_{market}
$$
The total revenue per kWh is then:
$$
P_{total} = P_{market} + Premium = P_{ref}
$$
Within limits and specific rules, this means that as long as the scheme is applied as intended, the generator effectively receives the reference price, independent of short term fluctuations in the market. If the market price rises above the reference price, the premium can even be set to zero or become negative, in which case the generator pays back the difference. In practice, many schemes include caps or floors to avoid extreme payments in either direction.
Sliding premiums are similar in effect to feed in tariffs in terms of revenue stability, but they keep trading and market participation with the generator. For policymakers, this can combine investment security with improved market integration, since the generator must forecast, schedule, and trade electricity, and often take some responsibility for imbalances.
Incentives And Market Integration
A key difference between feed in tariffs and feed in premiums lies in how they expose generators to the electricity market. Under a feed in tariff, generators are largely insulated from price fluctuations. Under a premium scheme, they see at least part of the price signal. This affects behavior in several ways, including how projects are located, designed, and operated.
With feed in tariffs, a developer might focus mainly on achieving maximum annual energy output, because each kilowatt hour is paid the same fixed amount. With premiums, especially fixed premiums, developers may also consider times when electricity is likely to be more valuable. For example, they may prefer locations where wind resources are stronger during peak demand periods or where grid constraints are less severe. Over time, this can lead to a renewable fleet that better matches system needs.
Market exposure also influences how generators manage forecasting and imbalances. In many premium schemes, generators are responsible for deviations between their scheduled and actual production. Accurate forecasting and participation in balancing markets become financially relevant. This can support grid stability and lower system operation costs.
However, increased market exposure also increases investment risk. Revenues depend not only on technology performance and support level, but also on future market prices. This can make financing more complex, especially for small actors who may lack expertise in market trading. Some designs address this by allowing aggregators to act on behalf of small generators.
Choosing Between Tariffs And Premiums
The choice between feed in tariffs and feed in premiums depends on policy objectives, market maturity, and institutional capacity. In early stages of renewable deployment, when technology costs are uncertain and market participation is unfamiliar to many actors, feed in tariffs can be very effective. They simplify investment decisions and can be implemented even in markets that are not fully liberalized.
As the market develops and the share of renewables grows, concerns about cost control and system integration often become stronger. Policymakers may then shift from tariffs to premiums, or may combine them with competitive allocation mechanisms such as auctions, which are covered in another chapter. Premiums can be particularly attractive where there is a desire to keep renewables active in the market while still giving them support.
The impact on different types of actors is also important. Feed in tariffs are often more accessible to households and small cooperatives, because they are straightforward. Premiums, especially if combined with obligations to trade and manage imbalances, favor larger, more professional developers or aggregators. Policy design can try to offset this, for example by keeping simpler schemes for very small installations while using more market oriented designs for larger plants.
Cost Control And Policy Stability
Both feed in tariffs and feed in premiums must be adjusted over time to reflect changing technology costs and market conditions. Policymakers use several tools to manage cost and volume, such as scheduled tariff reductions, automatic degression linked to deployment levels, and eligibility limits by size or total capacity.
If adjustments are made too slowly or unpredictably, there can be problems. Delayed reductions can lead to excessive costs. Sudden or retroactive changes can undermine trust and raise financing costs because investors fear that agreed rules may not hold. Effective schemes aim for transparent, predictable adjustment rules that are communicated clearly in advance.
Feed in premiums can offer additional cost control because they can be structured so that total support payments fall when market prices are high and rise when they are low. This can stabilize support expenditures from the perspective of the support authority. At the same time, policy design must prevent overcompensation and take into account that very low or negative prices may arise in systems with very high shares of variable renewables.
Illustrative Comparison Of Revenue Structures
To summarize the revenue structures, it is useful to compare them with simple expressions. Let $P_{market}$ be the market price per kWh and $P_{FIT}$ be the fixed feed in tariff level.
Under a feed in tariff:
$$
P_{total} = P_{FIT}
$$
The generator receives $P_{FIT}$ for each kWh, and this does not depend on $P_{market}$.
Under a fixed feed in premium with premium $p$:
$$
P_{total} = P_{market} + p
$$
The generator is fully exposed to price variation, but always receives $p$ more than the market price.
Under a sliding premium with reference price $P_{ref}$:
$$
P_{total} \approx P_{ref}
$$
Within the rules of the scheme, the premium adjusts so that total remuneration remains close to $P_{ref}$, while the generator still trades in the market.
For feed in tariffs, total revenue per kWh is fixed by policy and does not depend on the market price: $P_{total} = P_{FIT}$.
For fixed feed in premiums, total revenue adds a constant premium to the market price: $P_{total} = P_{market} + p$.
For sliding premiums, policy aims to keep total revenue near a target reference price, usually by setting $Premium = P_{ref} - P_{market}$.
Understanding these basic relationships helps make sense of how policy choices affect investor risk, cost to consumers, and integration of renewables into power markets.
Evolution Of Support Schemes
In practice, many countries have moved along a trajectory. They began with simple feed in tariffs to kick start deployment, then gradually introduced degression and volume controls, and later shifted toward more sophisticated instruments such as competitive auctions that award long term contracts with premium structures. Existing plants often keep their original support, while new plants join under newer schemes.
As technologies mature and their costs fall, policymakers can reduce support levels and rely more on market revenues. In some settings, the goal is that renewables eventually compete without direct support, while other tools, such as carbon pricing, become more prominent. Feed in tariffs and feed in premiums should therefore be seen as part of a broader, evolving policy mix, not as permanent instruments.
For learners, the essential point is that both instruments serve the same broad purpose to make renewable investments financially attractive, but they differ in how they share risks between investors, consumers, and the public budget, and in how strongly they link renewable generation to electricity markets.