Last week Carbon Tracker’s power & utilities team was in Manila to attend the launch of a UK government-funded project to help the Philippines with power market reform to manage energy transition risk. In this blog post we summarise what we learnt from our discussions with local experts and key stakeholders.
The project is funded by the UK government and has three objectives:
- Get buy-in from stakeholders on the inflection points of new and existing power generation investments, comparing the economic cost and financial liability of import-dependent coal in the face of cheaper alternatives such as renewables.
- Make recommendations for policymakers to encourage an efficient, technology-neutral power market that delivers least-cost power to consumers and industry.
- Issue guidance for financial regulators to ensure bond issuance documentation clearly stipulates the risks of new coal investments to protect investors.
Carbon Tracker, the Institute for Energy Economics and Financial Analysis (IEEFA) and the Institute for Climate and Sustainable Cities (ICSC) are the consortium carrying out the research for this project.
Energy transition in the world’s most dynamic region
Southeast Asia is a geographically expansive and populous region characterised by social and cultural variation. Southeast Asia governments desperately need access to cheap energy to develop as quickly as possible. The region’s rapid growth and development profile mean power demand will likely grow at 5-10% per year for the foreseeable future.[i] This means Southeast Asian power infrastructure will double in size every 7-14 years as governments prioritise building capital stock to provide critical infrastructure that the West takes for granted. Any policy that gets in the way of this priority will likely be marginalised or rejected.
Moreover, traditional stranded asset theory – i.e. the notion that assets are no longer able to earn an economic return due to the transition to a low-carbon economy – in the context of the Southeast Asia’s power sector is less relevant.[ii] This is because Southeast Asian governments either use the sovereign balance sheet to underwrite risk or have policies that provide significant and guaranteed returns for coal developers and financiers.[iii] Therefore, instead of company impairments, stranded asset risk from coal will more likely cascade through the economy and materialise with the consumer and taxpayer through higher energy costs and increased public debt.
How Southeast Asian governments respond to these challenges will have far-reaching implications for the region’s economic competitiveness and energy security.
3 grids, 141 utilities and 7,641 islands
There are 7,641 islands in the Philippine archipelago. As a consequence, the Philippines has two distinct markets for power: grid-connected and off-grid. Grid-connected regions are served by Luzon, Visayas and Mindanao transmission grids, while off-gird regions are served by decentralised sources of power such as PV and diesel. The Philippines power market is considered liberalised and includes 141 utilities that provide distribution services and connections within their franchise area.
Market liberalisation occurred in 2001 through the auspices of the Electric Power Industry Reform Act (EPIRA). The EPIRA required transmission, distribution and generation to be unbundled. This resulted in breakup of the National Power Corporation and the privatization of its generation assets.
Other liberalisation reforms included the:
- Establishment of spot market (termed the wholesale electricity spot market)[iv];
- Establishment of an independent regulator (called the Energy Regulatory Commission)[v];
- Privatization of the transmission system as a regulated monopoly[vi]; and
- Mandating of retail competition.
These liberalisation reforms contrast with other Southeast Asia nations such as Indonesia and Vietnam, who have highly regulated markets and typically subsidise power prices for the end-user. Indeed, by international standards retail power prices in the Philippines are exceptionally high when compared to the relative wealth of Filipino citizens.[vii]
According to IEEFA and ICSC[viii], stranded power generation assets in the Philippines are already occurring and is being paid for by consumers, and could continue to occur, due to a confluence of factors, including:
- overbuild in regions such as Mindanao;
- the deflationary cost of renewables;
- increased retail competition; and
- a new “carve-out” clause in power supply agreements (PSAs) for declining utilisation rates.
These trends may leave ratepayers and/or investors at risk via high power prices and uneconomic returns, respectively. According to IEEFA and ICSC, $21 billion of potential investments in coal capacity face stranded cost risks.
“In god we trust; all others bring data.”
It is the consortium’s view that coal power is in the process of becoming a high cost option and therefore will likely reduce the economic competitiveness and fiscal resources of nations that continue to rely on the fuel for power. However, the transition away of coal will unlikely happen at the scale and speed required if Southeast Asian governments:
- are unconvinced by the evidence base that a coal-free grid is going to deliver reliable, safe and secure power at least-cost; and
- fail to introduce competitive, transparent and non-discriminatory policies.
Regarding the Philippines, 9.4 GW of coal is in various stages of the planning process.[ix] According to the Philippines Energy Plan (PEP), which informs the government’s energy policy, coal will increase from 22% of primary energy supply in 2016 to 42% in 2040 under a clean energy scenario. [x] The PEP also references the importance of promoting clean coal technology and indigenous coal production.
In short, the Department of Energy in the Philippines currently believes coal will remain an important source of energy for the foreseeable future. The burden of proof rests with those who disagree with this outlook to prove that a coal-dependent future will lead to higher costs and stranded assets. A publicly available data and analytical framework is therefore essential to get key stakeholders to realise that there are cheaper options that can take advantage of renewable energy deflation.
With assistance from the UK’s BEIS and Foreign Office, Carbon Tracker, IEEFA and ICSC will be working closely with key stakeholders over the coming months to fulfil the objectives of this project. A report will be published in March 2020.
[i] According to BP statistics, from 2007 to 2017, power demand from Southeast Asian nations grew at 5.8% per year on average from 2007 to 2017. https://www.bp.com/en/global/corporate/energy-economics/statistical-review-of-world-energy.html
[iii] The Philippines does not use sovereign guarantees. The pass-through provision and guaranteed capacity payments in the old contracts means guaranteed returns.
[v] The EPC issue a certificate of compliance to interested and determine any power abuse or anti-competitive behaviour. https://en.wikipedia.org/wiki/Electricity_sector_in_the_Philippines
[vi] The National Grid Corporation is the transmission system operator for three grids and is in charge of operating, maintaining and developing the power grid. National Electrification Administration (NEA), the government agency in charge of power cooperatives, may act as guarantor for purchases of electricity in the WESM by any electric cooperative or small distribution utility to support their credit standing. According to the NEA, the distribution sector is composed of 119 cooperatives, 16 private utilities and 6 local government-owned utilities as of 2009. These distribution utilities may acquire electricity from generation companies or the WESM. Meralco is the largest distribution utility with a franchise area covering Metro Manila, the entire provinces of Bulacan, Rizal and Cavite, parts of the provinces of Laguna, Quezon and Batangas, and 17 barangays in Pampanga. https://en.wikipedia.org/wiki/Electricity_sector_in_the_Philippines
[viii] IEEFA and ICSC note that stranded assets, as defined by EPIRA, fall under two categories: 1) stranded debt, and 2) stranded contract costs. The former “refer(s) to any financial obligations of NPC which have not been liquidated by the proceeds from the sales and privatization of NPC assets (Section 4 vv, EPIRA).” The latter refers to “the excess of the contracted cost of electricity under eligible contracts over the actual selling price of the contracted energy output of such contracts in the market, which contracts shall have been approved by the then Energy Regulatory Board as of 31 December 2000 (Section 4 uu, EPIRA).” http://ieefa.org/wp-content/uploads/2017/10/Carving-out-Coal-in-the-Philippines_IEEFAICSC_ONLINE_12Oct2017.pdf