Additionality: A Concept Often Overlooked in Local Geothermal Energy Development

Photo c/o https://climatographer.com/

The term “additionality” is often used in the climate change space, pertaining to when greenhouse gas projects’ impact exceeds their initial targets.

Cambridge Dictionary defines the word “additionality” in two ways.

In an environmental context, additionality according to the Cambridge dictionary is when there is “the reduction in the amount of carbon dioxide gas released into the environment that happens only as a result of trading carbon credits.”

The Dictionary’s other definition is finance-related, with additionality being described as “the situation in which a government or organization is able to get money from another government or organization especially the European Union, only if it pays for most of the project itself.”

The Organisation for Economic Co-operation and Development (OECD) has identified three kinds of additionality in impact investing, namely financial additionality, value additionality, and development additionality. It is financial additionality that I would like to focus on in discussing the problems in our local renewable energy development

According to the OECD, financial additionality “describes a private-sector investment that otherwise would not have happened.”

Energy consultancy group in the Asia Pacific, Lantau Group has a simplified definition, describing the term additionality as “when someone takes an otherwise non-viable project and makes it happen anyway.”

We can take the concept of additionality and apply it to our local geothermal energy development conundrum.

Local geothermal energy development has been stagnant as very few private entities are willing to undertake exploration risks. Previously, the government shouldered the cost of the preliminary surveys of geothermal areas. Those days are gone now since after the passage of the Electric Power Reform Act or EPIRA, geothermal power exploration and development are left entirely to the private sector. The exploration costs are assumed by the private developer. So, we can say that private firms offer financial additionality when they embark on geothermal exploration and eventually development.

The Lantau Group stresses that additionality implies a premium, and “is clearly a requirement of the economic concept of making something happen that would not otherwise have happened. “

The research group further added that risk is an important element of additionality as investors typically spot an opportunity that looks attractive in current market conditions “but if that value proposition is incomplete or could deteriorate in the future, the investor has to consider risk.”

And there lies the problem with our renewable energy projects, particularly geothermal energy development. Unfortunately, our regulators fail to realize that additionality is about premium. Local regulators have such little appreciation of the risks being assumed by private geothermal developers. This can be seen in our current tariff setting.

I have discussed this lack of appreciation in a previous post. To recap, our tariff setting uses the Beta in computing for the cost of the equity under the Capital Asset Pricing Model or CAPM. The Beta determines the return on equity for any project.

Given the risks being assumed by the private sector in geothermal energy development, one would think that Energy Regulatory Commission (ERC) would offer a premium for the risks of geothermal energy development. Sadly, our ERC uses the same Beta across all power projects, failing to consider the risk profile of each power plant project. The CAPM is being incorrectly applied in our tariff setting.

So, as with the concept of additionality, why should investors put their money into developing geothermal resources when there is no premium to make something happen that would not otherwise happen? Geothermal greenfield exploration costs a lot of money. And one study done by the International Finance Corporation some years back showed that worldwide, only 60 percent of the explored holes turned out to be successful.

It’s clearly easy to see why investors are shying away from geothermal energy development as they are assuming high risks of exploration but won’t be properly compensated for assuming those risks. Again, for investors, a premium is needed to make something happen that would not otherwise have happened.

Revisiting the problems in geothermal energy development in the Philippines is not just timely but also necessary. For one, we are now experiencing rotational brownouts as of this writing given the lack of supply as more people turn on their cooling device this hot season.

For the entire first week of June, red and yellow alert statuses were raised on the Luzon grid. The grid operator was projecting a power supply deficiency of around 201 megawatts. The long-term solution, National Grid Corporation of the Philippines (NGCP) says is to add to the current power supply as demand continues to rise.

The NGCP has warned us of an impending power supply shortage in Luzon as early as March saying that operating margins were forecast to be thin from April to August this year. The grid operator called on policymakers and power industry players to address the impending shortage.

It was a warning that was downplayed by the Department of Energy (DOE) claiming that supply and demand projections don’t indicate any possibility of a red alert, although the Energy Secretary did admit in a Senate Energy Committee that a power generating capacity supply shortage does exist.

The current power supply and demand situation highlight the Philippines’ problem with energy security, particularly energy power supply problems.

More so, since there has been a moratorium on new coal power plants. Banning new coal-fired plants is a step in the right direction but without proper planning, the moratorium also leaves the country in a more vulnerable position. We are left with very limited options for baseload power plants, namely diesel, gas, and geothermal.

Geothermal power can act as a baseload plant, which is why it’s a great substitute for traditional sources of power. We can use geothermal to replace coal-fired plants.

Plus, new geothermal technologies are emerging. For example, there’s Google’s partnership with Fervo and Dandelion energy.

Fervo is developing the world’s next geothermal project, which will offer an “always-on” carbon-free resource. The company is working on how to use advanced drilling, analytics techniques, fibre-optic sensing, artificial intelligence and machine learning. Fervo aims to use AI and machine learning so the geothermal plants are more effective in responding to energy demands while fiber-optic cables can collect real-time data on temperature and flow of the geothermal resources so the best existing geothermal resources can be identified.

As for Dandelion, it’s making home geothermal heating more accessible. So far, the firm has installed hundreds of geothermal heating sites in New York and is currently improving its drilling technology to make residential drilling and heat pump installation easier and also more competitive with the current fossil fuels.

All these new technologies and developments in geothermal energy development should bode well for us as the Philippines have massive geothermal energy sources. Addressing the challenges hindering the growth of geothermal energy development in the country swiftly will go a long way in providing more baseload power and more alternatives for the consumers.

Thus, it’s important for us to review the concept of additionality and how our failure to provide investors with a premium is keeping us from using other sources of power for baseload. Our regulators need to incentivize investors. The government can no longer engage in exploration and development so it’s up to the private sector to make something happen that would not otherwise have happened or simply put help make more geothermal power more available.

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