August 16, 2020
By Sara Jane Ahmed & Alberto Dalusung III
IN recent days, the country’s energy sector has been abuzz with talk from the energy managers of a drive to accelerate indigenous energy development.
This is driven by the experience of the real fears of imported fuel supply insecurity for the whole energy sector at the onset of the pandemic,especially for the power sector. In private and public fora, Energy Secretary Alfonso Cusi has encouraged bolder development of renewable energy. This drive is both patriotic and scientific.
Rapid technological development driving the transition to a low-carbon economy means that electricity should no longer be expensive. Variable renewable energy can now meet or undercut the price of power from the electricity grid while cannibalizing the market for more expensive coal-based generation.
This realization has led Meralco, the country’s largest utility company, to acknowledge the risk of nonperforming stranded assets through a carve-out clause in their power purchase agreements that permits curtailment. It means Meralco can opt to buy less power from coal-fired generators under certain conditions. Accordingly, coal generators are no longer able to pass on unmanaged coal price risk to Meralco and its end-users.
Meralco confirmed at a conference last month that should it decide to buy less power, as seen in its 30-percent cut during the Covid-19 lockdown, coal generators would have to sell their electricity elsewhere. Coal-fired plants only operate efficiently in a narrow capacity band and if they run at below a certain threshold, the cost of fuel and maintenance rises.
Unlike some fossil gas and diesel generators, coal power plants have a minimum stable operating point requirement of 40 percent to 50 percent of capacity, resulting in significant risk of breakdowns at lower operating levels. With mounting competition from low-priced renewable energy and
storage options, market risk is rising for coal-fired generators and the investors and banks who hold their project debt.
Stranded fossil fuel assets have already led to high prices in the Philippines, as highlighted in a previous commentary. Over-reliance on baseload generation that is dependent on imported fuel has translated into high tariffs for consumers that can only temporarily be tempered under certain force majeure conditions. If Meralco had not invoked force majeure clauses in its supply contracts in response to the Covid-19 crisis, consumers would have been punished by a 15-percent increase in per kWh rates in Luzon. In contrast, electric cooperatives have been largely unable to trigger force majeure negotiations because of their small size, lack of negotiating power, and reliance on non-standardized contracts. The only option electric cooperatives can take to protect low-income households who rely on them for power is to request the waiver of the minimum energy off-take provision.
The current Covid-19 situation has highlighted the great and growing risks of over-dependence on coal-fired power, which cannot adjust to declining loads, forcing several to shut down. Failure to transition away from inflexible coal plants has already cost Philippine consumers dearly in the form of high electricity prices. Meralco’s carve-out clause is a step in the right direction to ensure that if power companies, investors and banks are foolish enough to ignore cheaper clean energy options, it is they—not customers—that will bear the risk, either in the form of a write-off or a non-performing loan.
Incumbent power sector players and their banks currently assume electricity demand will simply recover and coal can take back its dominant place. Demand will certainly recover, but it will do so under a modernized wholesale spot market that removes the automatic nomination of a minimum stable load in front of the dispatch (supply) order.
Therefore, coal plants will no longer have guaranteed buyers if they are unable to compete. The economics of coal will deteriorate further because even lower cost biomass plants without feed-in-tariffs (FiTs) will be given priority dispatch ahead of coal. The question then is this: as the market re-orients and assets become stranded for being uneconomical to operate, who will hold the debt exposure? Old power contracts leave stranded asset costs to end-users, while Meralco contracts from 2019 onward assign the cost to the power generator, and ultimately banks.
Given the pace of change in power markets, and renewed ambition to protect households and industry from paying for ill-advised risks, it would now be prudent for the Department of Energy (DOE) to render the Meralco carve-out clause as a standard provision in all imported fossil fuel contracts. Regulators ought to request for banks to sufficiently insure or cover risk of default from their fossil fuel power project loans.
Commercial and investment banks globally have been accelerating their move away from exposure to fossil fuel power. Considering the deteriorating economics of fossil fuel power and the fact that responsible managers have a fiduciary duty to protect their shareholders from known financial risks. Under current laws and regulations, directors are personally liable if they have breached their fiduciary duty to act in shareholders’ best interests. This is the time to consider if ignoring fossil fuel risks is a breach of fiduciary duty.
The Philippines’s financial regulators have already provided leadership in this sphere. The Securities and Exchange Commission has imposed mandatory environmental, social and governance reporting for publicly listed companies, and Bangko Sentral ng Pilipinas has approved the Sustainable Finance Framework to safeguard the financial system from the evolving material hazards of physical climate risk and transition risk, including stranded assets. Banks should now have the impetus to start pricing climate and transition risks and the value of the price stability and resilience of low-carbon ventures. Another step to take is to protect retail investors through appropriate bond disclosures that take into consideration the changed risk-profile of fossil fuel investments.
Planning norms for the power sector also need to be reconsidered in light of evidence that over-reliance on fossil fuel in the energy mix results in expensive system lock-in. Coal- and gas-fired units rely on inflexible take-or-pay contracts that guarantee dispatch even when new lower cost renewables can reduce system prices. Fossil gas in particular requires major infrastructure investment in terms of regasification units, associated pipelines and storage units. All this in turn will require from consumers the same long-term capital recovery guarantees as coal- and oil-fired generation. With cheaper domestic renewables entering the generation mix, power system planners, operators and investors need to reconsider assumptions regarding energy security, technology, finance and economic outcomes for consumers and industry.
It’s time to future-proof the Philippine energy market. New fossil projects should be required to provide estimates of how their technology might compete in eight to 10 years against other technology options. For instance, wind developer Triconti is preparing for a 1,200-MW portfolio of offshore wind turbines in Luzon and the Visayas. Offshore wind costs continue to drop as larger, more efficient turbines are deployed with higher capacity factors up to 52 percent. Unlike coal, offshore wind has no volatile imported fuel cost. In other words, the timing and production of offshore wind means it directly competes with imported coal.
We encourage DOE to recalibrate its planning process, including surveying generation options to grid capacity needs in order to promote capital efficiency and improve system design options. The DOE will find itself at the tip of the transition spear sooner once it recognizes the way in which the array of new generation options, including energy storage integration, can secure the agency’s cost-reduction and domestic energy security objectives for the long run.
• Sara Jane Ahmed is an energy finance analyst at the Institute for Energy Economics and Financial Analysis. Alberto Dalusung III is the energy transition advisor of the Institute for Climate and Sustainable Cities.
Image credits: Alexey Kornylyev | Dreamstime.com
This article originally appeared in the BusinessMirror last August 15, 2020.