Page last updated at 05:22 UTC, Friday, 09 November 2018 PH
There is a lot of hype about how solar energy can replace coal in the Philippines. I am glad that the Department of Energy is transparent enough in presenting its long-term projections for the energy mix in 2040. In its Clean Energy Scenario for 2040, coal will constitute 41.6% of the primary energy mix twenty two years from now as compared with 22.0% in 2016. Oil will still be at 32.2% of the energy mix in 2040 (compared to 34.9% in 2016). To the great chagrin of the solar-lovers, in 2040 solar (and wind) will not even make the 1% level. The officials of the Department of Energy are making the right choices in the trade-off between a spic and span environment and a lower cost of energy, especially for the majority of the population who belong to the low-income households. Power rates today in the Philippines are the highest among the Southeast Asian countries. In 2016, Filipino consumers had to pay an average of P8.61 per kwh compared to P4.58 in Vietnam, P5.48 in Indonesia and P6.01 in Thailand. Industrial users paid P7.19 per kwh in the Philippines, compared to P 3.64 in Vietnam, P5.48 in Indonesia and P4.55 in Thailand. High costs of power have a significant impact on the purchasing power of the consuming masses, especially in inflationary periods like the one we are now experiencing.
To bring down the solar-pushers to the real world, prominent energy economist Dr. Ricardo Barcelona has been writing articles for both international and local journals about what he calls “the green paradoxes.” Having written one of the most complete guides to investments in energy projects entitled Energy Investments, a product of his doctoral dissertation for King’s College in London, Dr. Barcelona alerts both policy makers and people in business about “why green energy experts may have it all wrong.” He is no ivory tower economist but has very practical exposure to the energy sector all over the world. He served in senior leadership roles at Royal Dutch Shell, Netherlands and London. He was also for many years an investment banker, having been top rated equity analyst and adviser whilst at SBC Warburg and ABN Amro/Rotschild. He lectures on energy economics at leading business schools both here and abroad.
A long-time resident of Spain, Dr. Barcelona has been a first-hand witness to the folly of subsidizing solar energy for years only to see the collapse of this sector in recent years. As he wrote in one of his articles, popular enthusiasm for variable renewable, particularly for solar power of late, is unmatched by the adopting firms’ very poor financial performance. Growth did not necessarily translate into profits. This has been generally the experiences in the big adopters, China and the United States which account for more than half of global installation. Germany and Spain, erstwhile leaders, have set the pace in Europe with Denmark carving a niche with its technological leadership. Generous subsidies were granted to renewables, especially solar, but the results have been disappointing. He is warning emerging markets like the Philippines not to follow the default policy mantra, “Subsidize your way to decarbonize the economy.” This has seldom delivered. Despite lenders limiting funding to coal-fired power assets, wind and sun have not energized our economies.
Focusing on the inherent uncertainties in decision making concerning energy sourcing, Dr. Barcelona identified the problem in how renewable are valued as individual projects, rather than as part of a portfolio of diversified supplies. Recognizing variable renewables’ higher costs, subsidies equalize the costs difference following grid price parity principles. While the difference in costs between variable renewables and gas or coal are relatively easy to calculate, the answers are indeterminate. Renewables’ costs are generally stable given their zero fuel costs. Cost of gas or coal, however, vary frequently with the energy markets. It then becomes difficult to derive a “correct” subsidy when stable costs of renewables are deducted from volatile fossil fuel costs. More often than not, subsidies set under presumed constant prices over- or under-compensate renewables. Given these uncertain results, subsidies seldom lead to wide scale deployment, thus leading to the so-called green paradox.
Unfortunately, the persistence of the green paradox and its causes are far from obvious. That is why, Dr. Barcelona goes out of his way to point out this book Energy Investments the following counter-intuitive propositions:
--Subsidies embed risks, rather than secure cash returns of investors.
--Take-or-pay, or power purchase agreements, increase financial risks from continual renegotiations.
--Rapidly declining solar costs reward late adopters, thus encouraging deferral of investments.
The traditional approaches to capital budgeting have a bias for predictability. Variations are frowned upon as risks that should be minimized, leading to the artificial fixing of prices or volumes. When markets are volatile, as they usually are, erroneous decisions are made. The penchant of financial analysts to ignore volatilities and their effects on feasible outcomes does not make dynamic energy markets less volatile. We must consider that there are two types of renewables. Modulated hydro and geothermal enjoy high utilization rates with flexibility to adapt supplies to fluctuating demand. The other type is variable renewables, such as wind and solar, characterized by intermittent supplies with no flexibility on volumes. Both benefit from zero fuel costs and minimal operating expenses. Low volume utilization, however, renders variable renewables expensive on a life cycle cost of energy (LCOEs) basis, notwithstanding the sharp falls in costs since 2010. Power storage offers hopes to remedy solar power’s shortcomings. Expensive supply stored in high-cost storage, however, may not result in competitive energy supply, even if flexibility is enhanced.
The first adopters of solar in the Philippines must have relied on the flawed logic of the traditional approach to capital budgeting as applied to energy projects. The staple tool for deciding on whether or not to invest in a project is the net present value (NPV) approach. Expected cash flows over life of the project are discounted to today’s value with their sum giving the payoffs. A sum is invested to build the assets so that payoffs could be earned. By deducting what was invested from the payoffs, the excess value accrues to the investors, or the NPVs. When NPVs are positive, the projects with highest NPVs get the cash first, followed in rank by the next projects. Unfortunately, in the case of energy investments, volatile markets wreck havoc on NPV’s well-ordered world. What is attractive when prices are forecasted may be a dud when markets turn adverse. Without the flexibility to reverse decisions, or adapt operations or supplies to changing market conditions, managers could only watch their hoped-for payoffs dissipate. The common refrain becomes “unexpected” market moves “surprised” the managers, hence they incurred losses that were not anticipated.
This predicament is made more complicated when investors trust in the longevity of subsidies, putting their fate in the hands of the legal framework. Policy makers, however, do not possess the omniscience to know how cost, much less how technologies would evolve in the future. By trying to pick a “champion,” policy makers usually “copy and paste” subsidies applied across different markets. In the case of the pioneers of solar in Europe, what worked well for a while in Spain failed in Romania, despite the latter’s more generous payments at the starting block. These practical difficulties may explain why the first adopters of solar and wind in the Philippines have been disenchanted with their original investments, no matter their very good intentions at the beginning. These insights provided by Dr. Barcelona in his book may explain why, despite the hype we often hear about solar, coal is here to stay for a long time. The book Energy Investments in available both in the local bookstores and online. For comments, my email address is email@example.com.