Policymakers typically design FIT payment levels using the following approaches:

• Levelized cost of renewable electricity generation provides a per kilowatt-hour (kWh) cost of renewable energy generation for the full duration of the project including construction and operation. Key inputs include capital, fuel, operation and maintenance and finance costs as well as projected plant utilization. This approach can be tailored by technology and project size, and it is often most effective at driving renewable energy deployment, as it clearly defines the return to investors.
• Value of renewable electricity is calculated based on the utility’s avoided cost of generation added to the ancillary grid benefits, such as peak power and stability, and the value of societal benefits, such as climate change mitigation and reduction in negative health impacts associated with lower emissions. This value can be difficult to accurately assess, but it can be estimated to determine the FIT payment level.
• Resource quality can be used to differentiate FIT payment levels, allowing the payment to be appropriately aligned with generation costs at specific sites. Designing tariffs in relation to resource quality can improve project siting flexibility and support reductions in grid balancing costs through geographically dispersing renewable energy development, thus improving overall reliability. For wind power, the “reference turbine approach” bases payments on comparison of a reference yield with turbine generation over a five-year period. Various other approaches, such as “annual percentage yield” have also been used by countries to set FIT payments in relation to resource quality.
• Auction-based procurement through tender mechanisms can be used as a hybrid approach to determine FIT payment levels. Under this approach, governments tender or request bids for projects from which a utility or distribution company will purchase electricity. Tenders are usually designed with a total capacity of projects that will be funded, with the government or utility choosing multiple winning bids until the total capacity equals the tender capacity goals. When compared with traditional FIT payment schemes, this competitive bidding often results in lower project costs (Philibert 2011). However, this process can encourage inexperienced developers to submit bids that are too low, resulting in a project that is ultimately unsuccessful. Policymakers can mitigate this problem through designing a two-phase tender process that requires bidders to demonstrate experience and technical capability before they submit a complete bid. As described below, some countries are combining FIT and auction-based approaches to support RE deployment.

Sources: Couture et al. 2010 and Levelized Cost and Levelized Avoided Cost of New Generation Resources in the Annual Energy Outlook 2014