We Pay Higher With A Weaker Peso

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The Philippine Peso has been falling against the greenback in the last few weeks. Tagged by Bloomberg as Asia’s worst performing currency, our currency has lost 1.6 percent this year. Bloomberg also noted that the Philippine peso is also the worst performer among emerging markets, only next to the Argentina Peso.

Both forecasts by DBS Bank and Bloomberg also predict that the exchange rate would be P52 to a dollar by year-end, In fact, according to DBS Bank, the weak peso could continue until middle of next year.

The weakening of the peso is a result of various factors. Unfortunately, a shrinking peso against the dollar is detrimental to normal Filipinos if we are talking about their power rates. The falling peso could spell doom for many Filipinos, mainly because the lower peso would increase power prices.

As I have pointed out in previous posts, our Power Sales Agreements or PSAs have the provision for the pass-on costs where the consumers pay for the foreign exchange and fossil fuel upward price adjustments. To put it simply, the consumers will pay for the weak peso in their electric bills.

Remember December last year where the biggest power distributor announced a P0.1011 per kilowatt-hour (kWh) increase because of the upward adjustment in the generation charge caused by the significant weakening of the peso against the dollar. A news report then noted that the peso slid down to P49.73 in November from P46.59 to a dollar from August of the same year. That’s almost a three peso difference in three months, which resulted in the increased electricity bill. We have to keep in mind that the largest DU in the country sources its electricity from independent power producers, which, unfortunately, have 90 percent of their billings in dollar denomination.

As I have discussed in detail, our energy planners have favored the ‘floating’ PSAs rather than fixed ones, thinking that it is cheaper. To simplify, these floating PSAs are not necessarily more inexpensive as there are unknowns specifically fossil fuel global price spikes and falling value of the peso against the dollar. These unknowns are, sadly, inevitable.

As with our experience last year in the above example, a weaker peso resulted in higher power prices. So, we cannot say that floating PSAs are cheaper because, in the end, the poor consumers will shell out more money when the inevitable happens.

This is why we need the fixed priced contracts. Under fixed priced contracts, consumers will pay the same amount for a specified period, let us say, 25 years, for their electricity. Fixed price contracts eliminate the need for users to pay for the pass-on costs or to simplify, pay for higher power charges when the peso falls against the dollar or when prices of coal or oil in the international market increases. I’m sure our consumers would appreciate knowing how much they would be paying for their energy consumption on a monthly basis rather than be surprised when their electric bills come.

Let us see the economic sense in having fixed price contracts for the sake of the end consumers. Rather than just fret on how a weak peso could hurt us, let us make the adjustments needed to ease the burden for the Filipinos who will shoulder the cost of the falling peso when they for pay their electricity. Surely, Filipinos have other uses for their hard-earned money.

REVIEWING CAPM: How to Truly Bring Down Power Rates in the Philippines

I recently came across and found the time to re-read a material written by renowned Energy scholar,the late Simon Awerbuch. I first encountered Awerbuch’s readings a few years ago. That article made me really reflect and understand why our consumer on the street, Juan de la Cruz, is probably getting a bad deal in his electricity prices.

In the material, Awerbuch discussed the Capital Asset Pricing Model (CAPM), and the importance of reviewing the traditional methods used in estimating electricity costs.  He asserted that traditional energy planning fails to consider the risk of price volatility of fossil fuels, which, unfortunately, has a negative correlation with the economy.

We use CAPM in our tariff setting. In my view,  the concept is misused. The reading made me think that if only our energy planners and regulators take the time to understand the concept and make the changes needed, then we will surely have lower power rates

For a long time, we in the power sector have been using the “least cost” approach to analyze which sources of power are cheapest or the most economical to use in the system.  We do this by comparing technologies where we conclude that certain fuel sources are “cheaper” than others. To exacerbate this further, we then go on and regulate what can be passed on to consumers based on the returns we want to give to investors rather than what consumers want nor deserve.

And for the Nth time, I say, we got this all wrong.  This is the reason why we find it extremely difficult to bring down power rates.

We need to look at our Power Sales Agreement or PSAs to understand what we are doing wrong. Reduction of energy cost is simple: regardless of the technology, introducing fixed-price long-term contracts will REDUCE power rates.

To understand the need to introduce fixed-price-long term contract, we first need to review the use of what I call the ‘floating’ power sales agreement.

Generally, PSAs have provisions to “pass through” or “pass on” foreign exchange and fuel prices to the end consumers. It is my contention that once we minimize PSAs with “pass through” or “pass on” rates and replace them with fixed price long-term contracts, we can truly bring down power prices.  Otherwise, as my good friend says, these “pass on” contracts will have to be, in the Visayan language, “pas-an” (to be carried) by the consumers.

In my other articles, I have always asked the question: which is cheaper, a floating PSA that is currently priced at P5.00/kWh or a fixed price PSA that is fixed at P5.10/kWh for 25 years? The traditional analysis will say it is the floating P5.00/kWh.  In fact, the way “rate impact” studies are done, most utilities calculate only the first year tariff and weigh the implications of that tariff when added to the current average tariff of the entire energy mix. The traditional analysis will conclude that, indeed, a floating P5.00/kWh is cheaper than a fixed P5.10/kWh.

Unfortunately, such analysis does not consider the possibility that the floating PSA can reach P10.00/kWh the following year should the value of the peso fall against foreign denominations or prices of fuel or coal significantly increase.

Choosing the ‘floating’ price is counter intuitive. Any businessman or even a housewife would rather pay a known fixed price because, from a budgeting perspective, it is far more convenient.  And more importantly, it is actually, conceptually cheaper. It is cheaper because the cost to hedge either the fuel or forex risk will have to be added on the P5.00/kWh if one is to adjust the cost of a floating PSA to reflect current prices of fuel or value of peso against a foreign denomination. And that is assuming there is such a hedge for 20 years.

But why is this penchant for choosing the floating PSAs embedded in our regulatory framework? For this, we can point to the calculation of the Weighted Average Cost of Capital (WACC) when computing for the Return on Equity (ROE) in the determination of the appropriate tariff for a particular PSA. Our regulators use the CAPM for tariff setting, but unfortunately, use an incorrect value for the beta in the computation. Our regulators assume that the beta has a positive value, which signifies that the return to the generator is positively correlated to the economy.

This indeed is a faulty assumption especially if used in the tariff setting for fossil-powered plants. On the contrary, studies have shown that oil price volatility has a negative relationship on macroeconomic activities. Awerbuch, simplified it best: financial betas of fossil prices must also be negative.

The above point leads me to the bigger, and more important question: why is the rate setting evaluated from the point of view of the generator? Since the consumer is taking the forex and fuel risks anyway, shouldn’t the consumer’s perspective be taken instead?  Shouldn’t we use the beta for consumers for a floating PSA instead of the beta of the generator?

First of all, we need to look at who bears the risk of having a volatile price.  How is Juan de la Cruz compensated for taking on this risk? This question is not even being asked right now.  This has to be asked because, in reality, Juan de la Cruz will end up subsidizing the generators if we insist on assuming a positive of the beta of the floating PSAs.

Given that we are calculating the required ROE in the WACC using a flawed “beta,” then the generators are getting a ROE far greater than they deserve. This leaves Juan de la Cruz in a sorry state.

BUT if we take on the perspective of the consumer, then the entire story changes.

If we want to compensate Juan de la Cruz for taking the volatility risk, then we must consider the financial evaluation of the floating PSAs. Otherwise, the traditional assessment will show that Juan de la Cruz is getting a “cheaper” floating PSA. However, this is a fallacy.  The proof of which can be seen from a mathematical calculation using the CAPM.

Comparison

Take a look at the table above.  Clearly, the floating PSA is riskier for the consumer than the fixed PSA because, again, the consumer bears the cost of the forex and fuel risk. Or to put it simply, the consumers pay more for the fuel and forex upward adjustments.

Now we have to ask: how much is Juan de la Cruz really paying for each type of contract?

A static price comparison obviously is wrong. One cannot compare one price alone, let us say a P5.0/kWh for a floating PSA versus P5.10 for a 20-year fixed-price contract.  We MUST take into consideration the WHOLE contract period.

It is however, IMPOSSIBLE to predict the future prices of fuel and the foreign exchange.  And one cannot possibly put the future prices inside the contract.  This is the reason why these volatile costs are “pass through” or “pass on.”  It is the consumers who will pay for the adjustments above the P5.0/kWh.

This begs the question of how to account for this uncertainty in the evaluation of cost for Juan de la Cruz.

The fixed PSA, on the other hand, is easy to figure out: it is fixed.

So, how can one evaluate what the real cost is for Juan de la Cruz? Common sense will tell you, the fixed price – as long as it is priced correctly – will be always be advantageous to Juan de la Cruz, all other things being equal.

Mathematically it can also be proven.  We still use the CAPM– the very same formula that is being used to determine the appropriateness of the tariff–except that this time, we use the CAPM from the point of view of Juan de la Cruz rather than the one of the generator.

CAPM

The formula above says the discount rate of any asset is equal to the risk-free rate plus a premium.  This premium is represented by the market return (MR) adjusted for the sensitivity of the asset to the return of the market.  Generally, in modern finance, the market return (MR) is defined as the return of the entire stock exchange, and the beta is the correlation coefficient of a particular stock against the return of the market.

If a stock’s price goes up or down with the market, then we say that stock is POSITIVELY correlated with the market.  The beta then will be a POSITIVE number.  If the stock’s price goes up when the market goes down and vice versa, then we say that stock is NEGATIVELY correlated with the market.  Then that beta will be a NEGATIVE NUMBER. If a stock price stays constant regardless of the behavior of the market, then we can say it has NO CORRELATION with the market. Then the beta will be ZERO.

Let us now apply the concept in evaluating the floating PSA versus the fixed PSA.

Let’s start with the easy one – the fixed price.

Since the price of the PSA is fixed (in real terms), then we can say it has NO CORRELATION with the movements in the fuel price or forex.  Or to put it simply from a consumer’s perspective—the consumer will pay the same price regardless of the fuel prices or forex. So, the beta will be ZERO, which means the discount rate we should use will be the risk-free rate. Let me go back to this number later when we do the analysis.

How do we handle the case of the “pass on” or floating PSAs?

Volatile prices, in general, will be NEGATIVELY correlated to the market, so the beta is a negative number. A simpler analogy is this: if the price of fuel or the cost of forex goes up, the value of the PSA goes down (becomes more expensive.) On the other hand, if the cost of fuel or forex goes down, the value of the PSA goes up (becomes less expensive). Clearly, there is a NEGATIVE correlation between a volatile PSA and the market.

Applying this logic to the CAPM, one will see that the discount rate for the fixed PSA will always be higher than the discount rate for the volatile or floating PSA (mathematical proof available upon request.) The reason is simple. In the case of the fixed price contract, we discount the price at the risk-free rate.

On the other hand, in the case of the floating contract, we discount the price at a rate LOWER than the risk-free rate.  Discounting at this lower discount rate will result in a higher price than one that is discounted at the higher discount rate.  That the mathematical truth.

How do we translate this to Juan de la Cruz?

This simply means, ceteris paribus, a fixed price contract will ALWAYS be lower than a floating volatile contract. And any analysis that does not take this into consideration is doing a disservice to the consumers. This also means that putting a fixed price contract into a utility’s energy mix will lead to LOWER power rates.

There is no magic in the CAPM formula. After all, anyone with some basic knowledge of calculus and finance can calculate using that formula. The major shift here is this: we should use the discount rate relevant to Juan de la Cruz rather than to the generator. It is the consumer taking the fuel and forex risks.  Hence, he must be compensated for taking on that risk. Using the generator’s beta (most likely greater than 1) to evaluate the PSA is wrong because the one paying the tariff is Juan dela Cruz and not the generator.

I am not saying that we should totally ignore floating PSAs. Floating PSAs generally are associated with fossil fuel-based contracts. I think the late Prof Awerbuch hit the nail on the head with his article. As he pointed out, “The CAPM analysis highlights some important implications of the negative correlation between energy prices and the economy, suggesting a broader conceptualization of energy security that reflects the deleterious economic effects of fossil volatility. These effects can be measured and reduced by incorporating technologies such as wind, geothermal and PV, whose underlying costs are uncorrelated to fossil prices. Fossil price risk can be mitigated only through such diversification.”

Unless this shift is made, Juan de la Cruz will always be screwed. It will be the consumer who will “pas-an” the generator because of the “pass on” nature of the volatile PSA.

Time to change.

Job Generation in Renewables

Going green, in this case, going for more renewable energy sources to dominate our energy mix has its rewards. Coal, as we have been discussing, is harmful to our environment, as well as health. Sourcing energy from renewables would lead to savings from medical expenses.

Aside from the environment and health-related benefits, there is one advantage of going renewables, an outcome that can help the lives of impoverished families And this is the focus of GreenPeace Philippines report, “Green is Gold: How Renewable Energy can save us money and generate jobs.” Renewable energy development generates employment. The report cited the example of Europe where the renewable energy sector employs some 650,000 individuals. The RE sector in Germany alone has roughly 370,000 jobs. Data from the German Renewable Energies Agencies stressed that there are more employment available in solar energy than nuclear and coal energy combined. Likewise, in Spain, its RE industry has already provided close to 89,000 direct jobs.

In its report, GreenPeace stressed that solar power could generate the highest number of employment. Research by the University of California, Berkeley pointed out that “photovoltaic technology produces more jobs per unit of electricity than any other energy source. Most of the jobs are in construction and installation of solar facilities and can’t be outsourced to other countries.” A good example would be the solar power business in Japan, where some 9,800 jobs were generated after completing the installation of a total of 360 MWp (megawatt peak) of PV power.

And it’s not just solar power that can provide employment. The study also showed that other RE sources could provide a great number of employment, too.  For example, a typical wind farm generating 250 MW can generate 1079 direct jobs–jobs in the manufacturing, construction, maintenance and operation of power plants– during the installation phase alone. Naturally, indirect jobs are created as well.

On the other hand, job generation figures of geothermal power are impressive, too.  A Philippine company that generates some 1,189 MW of geothermal power has directly hired more than 2,500 individuals.

At Emerging Power Inc. or EPI, we also employ locals in our various power plants including indigenous people. Our Mindoro power plant has employed some Mangyans while there are hundreds of Aetas working with us in the Subic solar plant. So far, we have roughly 400 individuals working with us, and this figure is likely to increase over time as we build more renewable energy projects.

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Workers at EPI’s solar plant in Subic.

Aside from giving them employment, EPI also provides them with the opportunity to go back to school through our CSR programs.  For example, our Alternative Learning Program sponsors individuals to go back to school regardless of their age. In fact, one of our recent high school graduates is a 47-year old Mangyan, who unfortunately had to quit school in the past due to poverty.

Clearly, growing our RE sector will help address the country’s unemployment problems especially when renewables provide more employment than coal-fired plants. A study by the University of Massachusetts, The Economic Benefits of Investing in Clean Energy in the US, noted that about 2.5 million new jobs are to be created when investments on clean energy reach a total of $150 billion. Concluding their report, the researchers added that “clean-energy investments generate roughly three times more jobs than an equivalent amount of money spent on carbon-based fuels.”

Again, I am not against coal power plants per se. In fact, I had helped built some them when I was with NAPOCOR. But times are different, and we need to make some changes to address the needs of our country and the earth.

We have to remember that we are a country that benefits from abundant natural resources. For one, we are the second largest producer of geothermal energy in the world. Plus, the Philippines has a long and hot summer, as well.  According to the National Renewable Energy Labor NREL, the Philippines has the potential of generating an average of 161.7 watts per sq. m., being one of the sunniest countries on the planet.

No doubt that we are set to gain more economically if we harness our resources properly. Building more power plants from renewables could help lower our unemployment rate which stands at 19.7% as of July this year.  RE doesn’t only help save the planet; it also helps improve the lives of so many through the creation of jobs.

References:

“Green is Gold: How renewable energy can save us money and generate jobs”. Greenpeace

Note: Data including geothermal, wind employment & NREL figures, cited UCLA Berkeley, University of Massachusetts & German Renewable Energies studies and definition of direct employment are included in the Greenpeace report.

Labor Force Survey. PSA. https://psa.gov.ph/statistics/survey/labor-force

The Pros and Cons of a MinPoCor

Recently, there are initiatives to push for the refiling of house bills, which seeks for the creation of Mindanao Power Corporation or MinPoCor, according to a Businessworld report. The new entity will be a government owned and controlled agency (GOCC) that will manage the Agus and Pulangi hydropower plants.
The report cited the interim head of the Mindanao Power Monitoring Committee (MPMC), Glenn Jay Reston saying that the MinPoCor “will help maintain affordable electricity rates in Mindanao and assure that the revenues earned will also be reinvested in the island.”
The House of Representatives of the last Congress passed a consolidated bill on the establishment of the MinPocor. However, the said bill failed to pass the scrutiny in Senate. Under the bill filed in the lower house, MinPoCor will operate as a stand-alone GOCC and will raise funds to operate and maintain the remaining power assets of the government in the region.
Now that the discussion on the MinPoCor has been revived, let us ask the following questions: Is it beneficial to create such a GOCC? What are the pros and cons of having the Mindanao power corporation?
On the one hand, having MinPoCor will address the power crisis in the island. It will be an entity that will focus on the needs of Mindanao’s energy sector. After all, the appalling power situation in the region is a result of the long neglect of the national government through poorly crafted government policies.
To stress this point, a report from the Asian Correspondent said that in 2009, the Philippine Chamber of Commerce and Industry already stressed that the island was in need of additional 100 Megawatts to keep up with the economic activities in the region. Plus, business and industry leaders were already asking the national government to address the need for additional capacity as estimates show that Mindanao will likely suffer from power shortages by 2011 if no new capacity were to be installed.
However, the previous administration failed to heed the calls for the additional base load capacity. It was no surprise then that a full blown power crisis interrupted in 2012, with the island suffering from at least 8-hour rotating black outs.
Given the above slow response of the national government to focus on the power situation in Mindanao, it might be in the best interest of Mindanawons to have an entity that concentrates on the power situation in the region.
However, there is also a downside to the creation of MinPoCor.
Being a GOCC, it is still a government entity and will suffer the same problems of a government monopoly, as well as bureaucratic issues.
The possible lack of funding for MinPoCor could create bigger problems as it could delay the much-needed repairs and rehabilitation of the hydro complexes in the region.
The essence of EPIRA is to privatize the government-owned energy assets. The government, after all, has limited funds for the maintenance and operation of assets. This said, it is probably better for the private sector with deeper pockets to take the commercial, operational and constructions risks of operating and maintaining the power plants. Otherwise, the government will need to borrow additional funds and pay for the interest of borrowing money.
There are various ways of going about the privatization of the hydro plants. In my opinion, the Power Sector Assets and Liabilities Management or PSALM could enter into a 25-year power supply agreements before bidding out the hydro plants. This is to ensure that low prices are kept low despite the privatization for the benefit of NAPOCOR’s existing clients including distribution utilities and industries directly sourcing their power from the said plants. Of course, this will be much more complicated given the implementation of the Competitive Selection Process or CSP but still can be done if the government acts on it.
Additionally, Pete Ilagan, President of the National Association of Electricity Consumers for Reforms Inc has suggested privatization through “cooperativization” where cooperatives will own the assets. According to Ilagan, this will ensure that consumers welfare prevails over the interest of big businesses.
We also have to consider that the creation of a new entity always comes with challenges. For one, the efficiency of a GOCC is questionable. GOCCs work under a framework of a democratic government where there is a separation of powers. A democratic government is, almost by definition, designed to be inefficient – there are strict rules on checks and balances. So, if one desires to have an “efficient” company, going through the GOCC way may not be the answer.
However, one can separate the ownership of an asset like the Mindanao power plants and the management of these plants. As government way of running things is based on a democratic framework– it does not have the discipline of profitability and efficiency that private capital will require. So, therefore, there is a way to compromise: the government can keep the ownership of the assets, but the management, including future investments, can be done by the private sector.
Before opening the management to the private sector, the government can enter into long-term power contracts with all existing customers. The government can, for example, fix the current power rate and maybe index to CPI for the next 25 years. This will ensure two things: the government asset will not compete with private generators and second, low power rates from these hydropower plants are assured for the next 25 years.
The private sector entity that comes in will then face the challenge of improving the efficiency of the assets by rehabilitating them and improving operations and maintenance to have an upside on their investment.
So, this is the challenge of a MinPoCor: have the discipline that the private sector (and consumers) require but operate within a framework of a democratic government. Otherwise, there will be no change in the cost structure nor ability to maintain these plants. It is essential to form a management team for the MinPoCor that is not only knowledgeable and transparent but also can approximate or surpass private sector management efficiency. Otherwise, the reforms needed to push the national government to pay attention to the power problems of Mindanao will remain unsolved due to the problems within the organization.
This is not to say the GOCCs cannot be run efficiently. I have seen some GOCCs and government agencies that are at par with the standards set even for private sector companies. These GOCCs are often those that have had the luck of having someone with a vision of running the GOCC effectively. However, these are few and far in between. As a whole and in the long run, the need to adhere to the principle of separation of powers will wear down on efficient management set in place by different administrations.
So, are the hydro complexes better off in the hands of a GOCC? While some may say the jury is still out, others disagree outright.
According to UP economist, Gerardo Sicat, there are several studies showing the success of privatizing hydropower plants:
“There is growing evidence that the privatization of the hydroelectric power plants in the whole country is working well. With the government being relieved from the task of operating the generating plants, gains in efficiency and in service delivery improvements have become noticeable among the privatized plants.”
So, just how beneficial is the creation of the Mindanao Power Corporation? It’s also advantageous to have an entity that is dedicated to the needs of the island. But on the other hand, the possible lack of funding and management problems may exacerbate the woes of Mindanao’s power sector further. There is a way out – the government can keep the assets and maybe even transfer these assets to MinPoCor.
In summary, one need not privatize the ownership of an asset – it is the management of these assets that may need private sector discipline. Further, to ensure a fair level of power rates, the government can enter into long-term power sales contracts with all current consumers of Mindanao. If the management of these assets is privatized, the private investors should have the incentive to invest in the rehabilitation of the power plants so that its efficiency is enhanced thus giving the investors the upside that they are looking for.
In the end, everyone wins: the Mindanao consumers are happy because their low rates are assured for the next 25 year and the government and the local governments should be happy because the assets are not privatized. The MinPoCor proponents can even lobby to have these assets transferred to MinPoCor. Plus, the private sector is happy because a chance to invest in the power sector is open to them.

References:

http://www.econ.upd.edu.ph/perse/?p=913

http://www.bworldonline.com/content.php?section=Economy&title=mindanao-power-corp.-backers-push-for-law-ahead-of-agus-pulangi-privatization&id=135866

http://www.philstar.com/nation/2015/05/27/1459319/bill-creating-mindanao-power-corp.-passes-house-joint-committee

Energy Book by Myrna Velasco

http://opinion.inquirer.net/83960/better-way-to-privatization

 

 

It’s About Time

President Rodrigo Duterte made strong pronouncements after attending the Asia Pacific Economic Cooperation in Peru, promising to open up our utilities to more competition.

In his speech delivered in New Zealand, the president said “The only way to make this country move faster to benefit the poor is really to open up the communications, the airwaves and the entire energy sector. My decision now is to open the Philippine economy to other players.”

He further added that the government is “now also looking into regulatory requirements and institutional arrangements to hasten the entry of new players in the power industry and energy sector.”

This is good news for us, not only for energy players like myself but the rest of the country. I have long been advocating for the opening up of the sector to more players, including foreign ones. I have always been vocal in my desire to lift the 40 percent restriction on foreign ownership to address the energy needs of our country for several reasons.

For one, the building of power plants, particularly renewable energy plants is capital intensive, and there are very few local businessmen who can cough up the needed money to explore and build RE plants. The government no longer spends for the exploration of renewable energy and has left the task to the private sector. Unfortunately, exploration is not a cheap undertaking.

Take the case of geothermal energy where drilling of a single hole can cost $5 million, and that doesn’t include expenses incurred for the feasibility studies before drilling.

What we need are foreign investors who can shell out the money and provide the technologies needed to harness the energy from renewable sources because local businessmen do not have them. What we can do is to limit the foreign ownership of the renewable sources, but welcome more foreign investors to own equipment needed to convert our resources.

There’s another reason why the energy sector is ripe for more foreign ownership. The International Energy Agency or IEA has reported that roughly $165 trillion funds are ready for renewable and efficiency efforts from the years 2020 to 2030 after the government heads last year signed the agreement to reduce and limit carbon emissions to help save the environment.  This means the Philippines can take a share of that pie if we open ourselves to more foreign owners. We are, after all, a natural choice to receive these funds given the country’s abundance of natural resources.

The Philippines has been one of the fastest growing economy in the region and the Duterte administration is determined to keep our economic growth momentum that will be felt by the Filipinos. But the government can only accomplish such by building infrastructure to support our economic growth including power plants for stable and affordable energy supply.

Hopefully, the president can achieve his goals by having a cooperative Congress that will push for the needed changes in the Constitution. This necessary change is long overdue.

Reference:

http://business.inquirer.net/220139/digong-opens-3-sectors-foreign-investors

 

Inaction vs. Action: The Cost of Choosing “Cheap”

Quite a number of articles I have written on this blog discussed the portfolio theory, which essentially debunks the myth that choosing traditional forms of energy are more economical.  As I have been saying, our penchant for choosing the energy source based on current market prices or what we term as the least cost method for energy planning, may, in fact, be more costly in the long run.

However, what I have written focused on the cost of building the power plants and energy generation. There is one aspect that makes traditional sources of energy more costly for everyone: the impact on the environment.

Perhaps, it is still unclear to many what the relationship between climate change and the use or non-use of traditional sources of energy. To put things in better perspective, we should illustrate why we must choose renewable energy with the following numbers:

According to the report ‘Energy Darwinism: Why a Low Carbon Future Doesn’t Have to Cost the Earth’, published by Citi, the power sector contributes roughly two-thirds of the total greenhouse gas emissions. On the other hand, other sectors such as land use, agriculture, and forestry, as well as other industrial processes combined only contribute a third of the overall greenhouse gas emissions.

To make matters worse, 90 percent of the greenhouse emissions of the energy sector are carbon dioxide emissions or CO2 since most greenhouse emissions are C02.  However, 65 percent of CO2 emissions from the sector are from fossil fuels and other industrial processes.

Given the above figures, surely, we can no longer say that the fossil fuel powered plants are the cheaper options.

Fortunately, the report of the third largest bank in the US also includes an analysis of the cost implications of continuing with the world’s current heavy reliance on fossil fuel versus the cost of changing the energy mix to include more renewable energy.

What Citi did in its report is to analyze two scenarios: the cost of inaction and action. Under the inaction scenario, the world will continue its energy consumption patterns that are heavily reliant on fossil fuels. Under this assumption, there would be a slight pick-up in renewable energy investment, but the penetration rate of RE will stay at 6% by 2040 and fossil fuels will compose of two-thirds of the power mix. This scenario also assumes zero investments in energy efficiency, which will result in a compound annual growth rate (CAGR) of 2.4% of electricity generation from 2015 to 2040.

On the other hand, the Action scenario assumes that the energy mix favors renewable energy as solar and wind will contribute 22% of the energy mix while fossil fuels are reduced to 28%. The penetration rate of RE also increases to 34% from a mere 6% in 2012.

Is there a difference in costs of the Action and Inaction scenarios? The report says yes, one scenario costs more than the other. Contrary to popular belief, though, the cost of taking the Action scenario is cheaper than the Inaction scenario: the business as usual energy mix is at $192 trillion while the low carbon option will only cost $190.2 trillion from 2015 to 2040.  Citi notes that the falling costs of renewable energy coupled with less dependence on fuel usage account for the cheaper costs of the Action scenario. The report stressed that “Yes, we have to invest more in the early years, but we potentially save later, not to mention the liabilities of climate change that we potentially avoid.”

 

action-vs-inaction

Cost of Action vs Inaction. Source: Citi Research

What would it cost the world if we choose the Inaction route?

 

A report written by Lord Stern with the title “The Economics of Climate Change” in 2006 warned us of the possible overall costs of failing to act on the risks of climate change. The report, widely known as the Stern Review, concluded that losses from effects of climate change would be five percent of the world’s gross domestic product (GDP) per year between ‘now and forever.’ It could even be as high as 11% when we include other effects on the environment and health, which, unfortunately, are hard to quantify.

There are also other research papers that tackled the potential losses in GDP due to damages from climate change. The Citi research noted that a temperature increase of 2.5°C could result in loss of 0.9 to 2.5 % of the world’s GDP.  A loss of 0.7% to 2.5 % of the GDP is roughly % $44 trillion, the report said.

Aside from losses because of climate change, there are also losses in GDP due to heavy reliance on traditional sources of energy.  In a study, Professor Shimon Awerbuch noted that the oil price spikes in the years 2000 to 2004 cost the European Union €700 billion. The prominent advocate of portfolio theory in energy planning further noted that the world would avoid losses of $95 to $176 billion for at least an addition of 10 percent renewable energy in the mix.

The findings of these reports may vary in their calculations, but it is clear that it’s time to do away with thinking only of short-term prices in energy planning. What we should do is plan our energy needs with the future in mind since our penchant for looking at the current and short term costs are and will cost us more. And unfortunately, the costs are not purely monetary

We favored what we thought was cheap. Sadly, what we thought would save us money is making us pay more. The Citi report summed the situation best “A simple reason why atmospheric concentrations of greenhouse gases has grown is that they have been put there as a result of our using historically the cheapest, easiest, or most readily available solutions to a requirement, such as energy. To look at it another way, adopting a lower carbon path is (at least superficially) more expensive, otherwise all things being equal we would logically have gone for a cleaner option.”

References:

Energy Darwinism: Why a Low Carbon Future Doesn’t Have to Cost the Earth by Citi

The Role of Renewables in Enhancing Energy Diversity and Security: Portfolio Approaches by Shimon Awerbuch

Fluctuation and Energy Costs

It has been in the headlines; the Philippine peso hit a 7-year low when it breached the P48 benchmark in September. The falling value of the peso against the dollar worried many people, as it impacts many businesses, especially those firms whose loans are in dollars. On the other hand, dollar-earning Filipinos such as our OFWs are probably rejoicing at their increased purchasing power.

But what many fail to realize is that the average Filipino families are affected by the strength of the dollar against the peso. In fact, Filipinos will have to shell out more for electricity if the peso continues its depreciation. After all, importation of raw materials of traditional sources of energy is mostly US dollar denominated.

It doesn’t help either that coal prices in the world market, according to Meralco are getting more expensive. The falling peso value against the dollar and the increase in coal prices then makes an unfortunate consequence for us: higher generation charges.

Such is the price we have to pay for choosing what we thought was the least cost. I have been consistent in explaining the perils of favoring the least cost method of energy planning.

We have for the longest time been favoring fossil fuel generation over renewable energy because of our penchant for choosing the least cost in terms of current market prices. In energy planning, this means choosing coal-fired plants over renewable energy to dominate our energy mix. At a glance, coal plants seem cheaper. Plus, it is faster to build. On the other hand, renewable energy power plants require higher capital.

Unfortunately, looking at only current prices can be misleading as it fails to consider other factors, particularly, the higher costs of raw materials. Consider this example. One may build a coal-fired plant at $1/kWh based on current prices or a solar power plant at $4/kWh for the next 25 years.

What would be the ‘cheaper’ option?

At first, we may think that coal is the cheaper option. However, what if the international prices of coal go up significantly in the future? It is a given that the cost of producing electricity would be far greater than $1/kWh, and could even double, triple, quadruple and so on.  We have already been in this situation many times in the past. For example, we suffered from the changing policies of coal producing nations when a few years back, Indonesia decided to stop exporting some certain grade of coal. We ended up paying more for electricity since the Philippines is a heavy importer of coal from Indonesia.

And we are back again in a scenario where we will likely pay more for the higher costs of coal. With the falling peso value against the dollar, we are likely to make a dent in our pockets when it’s time to pay our electricity bills.

On the other hand, choosing to build solar powered plants means a guaranteed cost for next 25 years. That means being free from the risk of having to pay more in the future for events that are beyond the consumers’ control.

So, is it really cheaper to depend heavily on fossil fuel power plants? Maybe not, if we consider that world events such as the US Federation’s announcement of maintaining their current interest rate—the cause of the strengthening of the US dollar— indeed happen and they affect the cost of our electricity.

Let us also remember, too that prices fossil fuels are likely to spike as these resources are slowly depleting. In fact, the world’s consumption of fossil fuels outpaces the world’s production of coal and fossil fuel.

Our energy mix is under review headed by our Climate Change Commission. Hopefully, the review results in an energy mix that is dominated by renewable energy sources, not only because it will be beneficial for our environment, but also because it will help the consumers’ pockets.