The impact of feed-in tariff degression on R&D investment in renewable energy: The case of the solar PV industry

Abstract

Feed-in tariff (FIT) is a broadly used policy instrument around the world, in which the payment level is always designed to decline gradually in order to track and encourage technological improvement in renewable energy. However, the potential adverse effects of tariff degression on renewable energy research and development (R&D) investment have not been sufficiently addressed. In this paper, we explore the impact of FIT payment degression on renewable energy R&D investment and analyze the efficient FIT payment structure for R&D investment. We form a modeling framework that captures the dynamics of FIT payment levels and the inventor's strategic reactions to tariff changes. In this framework, we model the inventor's optimal R&D investment decisions based on the canonical real option approach and simulate the impact of FIT payment degression on R&D investment and the efficient FIT payment structure under different R&D characteristics using the case of the solar photovoltaic (PV) industry. Our results emphasize the adverse effect of tariff degression on the commercial value of new renewable technology and hence the inventor's incentive in R&D investment, especially when facing more technical uncertainty and financial constraints. Our model could help policymakers to design an efficient FIT payment structure through which the cost of the FIT program is restricted to a minimum level but without influencing the inventor's R&D investment decisions. • The impact of FIT changes on renewable energy R&D investment is explored. • A real option approach is proposed to model the inventor's investment decisions. • The simulation is performed using the case of the solar PV industry. • Implications for policymakers on the design of FIT programs are provided.