ECONOMICS AND FINANCING OF RENEWABLE ENERGY ...

ECONOMICS AND FINANCING OF RENEWABLE ENERGY SYSTEMS IN DEVELOPING COUNTRIES Dorothee Reinmüller, Dieter Seifried International Solar Energy Society (ISES), Wiesentalstr. 50, 79115 Freiburg, Germany, Tel.: +49 761 45906-54, Fax: +49 761 45906-99, [email protected] Barbara Praetorius DIW German Institute for Economic Research, Königin-Luise-Str. 5, 34195 Berlin, Tel.: +49 30 89 789–676, Fax: +49 30 89 789–200, [email protected] Ole Langniß Lund University, Gerdagatan 13, 223 62 Lund, Sweden, Tel.: +46 46 222 9871, Fax +46 46-222 8644, [email protected] Abstract – In the SEPCO project, different case studies referring to energy efficiency technologies and renewable energies for low-income areas in developing countries were investigated in detail. In this paper, two case studies that refer to financing issues will be presented: 1. A model to promote wind energy in Cuba that would be cost-neutral on the Cuban economy was designed. In this fund model, investors receive a feed-in rate from the wind turbines that is in line with the avoided costs of the generation of electricity. 2. A tourism levy model to fund the electrification of Mexico’s rural areas is proposed. The levy would be used as an instrument of closing the urban/rural gap in Third World countries, thus also reducing social tensions. This paper gives relevant economic calculations on the proposed fund model for wind energy generation as well as details on realisation options for a tourism levy and the amount of money it might procure. 1. INTRODUCTION Since the United Nations Conference on Environment and Development in Rio de Janeiro in 1992, the goal of “sustainable development“ has been accepted as a global priority. One aspect in particular that does not live up to the expectation of global sustainability is the energy supply of industrialised countries. This requires fundamental restructuring if the aim is to be achieved. The per capita energy use in industrialised countries is between 10 to 20 times higher than in most Third World Countries. This situation is further exacerbated by the fact that energy is mostly provided through fossil fuels. Germany, e.g., depends on fossil fuels for more than 90 % of its primary energy requirements. Burning fossil fuels causes harmful emission, in particular of CO2, which aggravates the greenhouse effect and leads to a changing world climate. The extensive damages caused by floods, hurricanes, and droughts are already being felt in industrialised countries and will eventually lead to increasing societal costs. However, the populations of Third World Countries are affected even more than the main contributors to the greenhouse effect: They have very limited resources to adapt to or compensate for the effects of climate change and its consequences, due to their difficult economic situation. Although in absolute numbers, Third World Countries contribute considerably less to the greenhouse effect than industrialised countries, similar energy waste patterns can be found in their metropolitan areas: Industrial production processes are not energy efficient, and economic saving

potentials in both households and industry are not effectively used or completely disregarded in most countries. In contrast, many people who live in rural areas do not have access to electricity. This has dramatic impacts on their quality of life, and in particular on their health, since they usually burn pollutant energy sources such as wood, kerosene or diesel. This lack of access to energy provision has negative effects on the development of rural communities. The provision of clean energy sources and efficient technologies is a basic condition for sustainable economic development in developing countries. However, can third world countries afford these technologies? Against this background, the German Federal Ministry for the Environment, Nature Conservation and Nuclear Safety (BMU) commissioned the SEPCo (Sustainable Energy Policy Concepts) project. The goal of this project was to develop instruments and policy tools for improving energy efficiency as well as increasing the application of renewable energy sources in developing countries. The project built on experiences made in Germany as well as in three model countries (Cuba, Mexico and South Africa) and other third world countries. This paper presents an overview of two examples of the work done in the course of the SEPCo project. For more detailed information, please visit the web-page: http://sepco.ises.org.

2. FINANCING WIND POWER IN CUBA Cuba’s electricity supply is largely based on inefficient oil power plants, fuelled with imported crude oil. Due to increasing world market prices, this production structure poses a constant threat to the Cuban economy. Even the exploitation of domestic oil resources would not change this picture entirely: domestic oil could better be sold on the international market at world-market prices than used for inefficient power generation. Electricity generation from wind energy could reduce the dependence on oil and also lower the overall costs for electricity production. Therefore, the following proposal was developed: the Cuban government can offer a power purchase agreement for electricity fed to the grid from wind energy equivalent to the variable costs of electricity generation (only fuel and other variable costs) in Cuban power plants on the basis of crude oil at world market prices. Neither cost nor risks would be imposed on the Cuban economy. In the following, the principles of the regulatory system are developed and the feasibility study for the proposed project presented. 2.1 The situation of the energy industry in Cuba In 1990 over 95 % of the country had electricity. UNE (Union National Electrica) is the only electric utility in Cuba. Since 1990 Cuba has had a rather constant power plant capacity at approximately 4.100 MW (Hennicke 2000). With 15.240 GWh in the year 1989, the energy production reached its highest point. In the following three years, the production of energy dropped about 25 %.1 After that, the statistics show a moderate increase. In 1999 the Cuban power plants produced around 13 TWh of electricity. The structure of the utilization of fuel for the production of electricity is represented in figure 2. The dominant share of electricity is generated through the use of crude oil. Other important input energies are sugar cane and natural gas. The power supply suffered under the complicated supply situation after 1991: in 1993/1994 there were power cuts on 300 days. After 1994 the supply situation was finally improved. Through the partial modernisation of power plant technology and the construction of new oil-fired plants (250 MW Russian and Czech plants) and new gas plants (total 360 MW scheduled), the available capacity increased. (Hennicke, 2002)

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The economic crisis in Cuba following the collapse of the Soviet Union caused this drop. The sudden loss of economic support from the CIS states (such as cheap delivery terms for crude oil and the purchase of sugar) led to a general drop in economic activity in Cuba.

oil 87 %

sugar cane 5%

gas 6%

hydropower 2%

Figure 1: Ratio of energy carriers for electricity generation (Valdez, 2002)

The losses in transport and the grid are very great, exceeding 20 % according to GTZ.2 (GTZ, 2002) 2.2 Description of proposed feed-in regulation In Germany, the Renewable Energy Act is the central promotional instrument for the generation of electricity from regenerative sources of energy. This law ensures that operators of regenerative power plants have a set feed-in rate over a period of 20 years based on the production costs for their specific technology. The additional expenses for this fee above costs for electricity generation in conventional power plants are spread across all utility companies/electricity consumers in a proportional contribution system. As long as conventional electricity generation is cheaper than generation from regenerative sources of energy, this regulation provides a burden on the macroeconomic level3. At the same time, this promotional policy creates new jobs and increases the competitiveness of regenerative technologies in international markets. These good, reliable general frameworks have made Germany the world leader in newly installed wind power in the past few years. In 2001, 6.800 MW of wind energy were installed worldwide. 40 % of this increase came from the Federal Republic of Germany (press release of German Ministry for the Environment, 6/2002). In light of the difficult economic situation Cuba is facing, no direct transferral of the German Renewable Energy Act seems possible as such a regulation may increase the costs for energy provisioning at least in the short to mid-term. To rule out an additional burden on the Cuban economy, a feed-in model is proposed that adapts the compensation for wind energy fed into the grid to the avoided costs for electricity production from conventional power plants. In turn, that means that the feed-in rates are coupled to the costs of the use of oil in the power plants. Should the price of oil rise, the electricity production would also have to be compensated 2

Distributed power feeds would lower the transport losses. The reductions in losses due to the grid would be progressively rising. 3 The external costs avoided are initially not included in this equation.

higher. As the same amount of oil imports are avoided, the total electricity production costs do not rise – on the contrary: they fall because the power plant capacity is saved.4 As for financing, funding for the wind farm can be expected to come mostly in form of private foreign capital investments and CDM. In this case, there is no risk at all for the Cuban economy. Such a project could also be carried out as a Joint Implementation project or within the frame of the CDM. The reduction of CO2 emissions through the investment would be credited to the enforcing company. Within Europe-wide certificate trading including CO2 emission rights, the investment could be carried though to the advantage of Cuba and the investing companies/funds.

Figure 2: Financing/remuneration model for wind energy

Hence, the central points of the proposed feed-in regulation aim to make the use of modern wind turbines economical without burdening the Cuban economy or other electricity consumers: • The Cuban government guarantees the investors (private Cuban and foreign investors) a set feed-in rate based on the avoided fuel costs of an oil-fired power plant, the avoided capacity costs, and the avoided grid losses. • The avoided fuel costs are based on the world market prices divided by the efficiency of the marginal power plant (the plant idled to allow for the feed of wind energy into the grid)5.

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Through the construction of wind power plants at least parts of the newly built capacities could be counted as reliable power. Calculations for different countries show capacity effects between 10 and 20 % of the installed capacity. 5 As the use of a power plant is generally based on economic rules, the first power plants taken off the grid will be the ones with the least efficiency and hence the greatest fuel costs.

• The oil price will be averaged for the year based on 12 average monthly prices. Defined types of oil will be used for the determination of this average price. • The avoided capacity costs refer to the situation in which several wind turbines/wind farms sell electricity to the grid at various locations, thus helping to cover capacity. The avoided power plant capacity is estimated at between 10 and 20 % of the installed wind power capacity. The comparative costs are investment costs for a new, conventional power plant in lieu of expanded wind energy. Alternatively, an agreement might be possible that reflects the contribution to covering capacity in suitable feed-in tariffs for specific time zones. • The investors are to cover grid connection costs. The Cuban energy providers will cover the costs for improvements to the transit grid. • The feed-in rates will be set for 20 years. • The foreign investors can freely transfer revenue from the feed-in fees. • Tax questions, such as writing off initial losses for the wind farms, still have to be clarified. The costs for electricity generation in 2001 were 6-7 US cents, according to Cuban figures. In the west of the country, the avoided costs are even greater as much of the power plant capacity is in the east; hence, transport costs and losses will be reduced greatly when energy is sold to the grid in the west. 2.3 Avoided CO2 emissions The specific emissions per generated kilowatt-hour are very high due to the current power plant technology and the predominant use of crude oil as fuel. If the assumed power plant efficiency is 30 % and grid losses are around 10 %, the avoided kilowatt-hour or the kilowatt-hour fed into the grid at distributed points will lead to a reduction in emissions of 1,1 kg of carbon dioxide. 2.4 Feasibility study A feasibility study for private investors was conducted for the feed-in regulation described above. The following assumptions were made: • One or more wind farms with 100,5 MW capacity are set up. The wind farm consists of 67 1,5 MW turbines. • The wind farm requires an investment of US$ 118 million (including costs for realization and capital acquisition). The technology costs per installed dollar of wind power are US$ 1.000. This includes all of the costs for set-up, grid connections, and initiation. • 60 % of the capital will be provided by private investors who get a share of the profit and risks involved in the capital investment. The rest of the investment is financed by bank credit (6 % interest rate). The guarantee for the bank credit is provided

by the transfer of ownership of the plants or a guarantee from the exporting state. • The annual operational hours for the nominal power of the wind farm were assumed to be 2.500 hours. • The service life of the wind farm is set at 20 years. Increases in maintenance and servicing costs were assumed for the duration of the life of the farm. • A total of US$ 5 million was calculated for the deconstruction of the plant at the end of its service life. • The underlying oil price for this model calculation was US$ 20 per barrel. The average price per barrel in 2001 was around US$ 24,4. An average nominal price increase of 3 % was assumed for the development of the price of crude oil. • The avoided CO2 emissions from the wind farm are to be marketed in the framework of the CDM mechanism. It was assumed that Cuba will be able to market half of the saved CO2 emissions. A price of US$ 10 per ton of carbon dioxide was assumed. • The external costs for conventional electricity generation with mineral oil that are avoided with the use of wind energy are assumed to be within the range of 3 to 11 Euro cents in a study by the European Commission (EC, 2001). The avoided external costs are not taken into consideration in this feasibility study but only provided for your information. Based on these assumptions, the project is economically viable even without the inclusion of state subsidies: the returns for private investors will be around 5 to 10 %. The actual returns would greatly depend on the average price of oil during the technical service life of the wind turbines. If oil prices rise steeply, the returns for investors will be much greater, while the capital investment would post losses or a very low rate of return if oil prices fell. The Cuban state could benefit from the investments in a number of ways irrespective of the oil price as described below. The marketing of CO2 reductions could bring in some US$ 700.000 annually. 2.5 Advantages of the concept The proposed concept offers a number of benefits to the Cuban state. • By setting up wind turbines and wind farms, Cuba will be taking considerable steps towards a sustainable energy supply. In doing so, the country will not be running any financing or capital risks. • Dependence on oil imports and the risk of price fluctuations based on the world oil market would tend to decrease, • Power plant capacities would expand without additional costs. • The set-up of wind power plants will reduce emissions and hence considerable external costs for Cuba. As Cuba’s power plants are fired with heavy heating oil with high sulfur content, the external

costs for electricity generation are extremely high. This means that under certain circumstances the external costs of the generation of electricity are greater than the costs determined in conventional business terms. (G8, 2001) If wind power were expanded to provide 10 % of the total generation of electricity, the avoided external costs would amount to 7,5 million Euros even at the lowest estimation of 3 Euro cents per kilowatt-hour. • The construction of wind power plants will create local jobs even if the entire systems are imported. The laying of foundations, the erection of the wind turbines, grid connections, and servicing will create new jobs. Around two thirds of the investment costs go towards the costs for the system. One third goes to the installation of the system. Hence, foreign currency will enter the country as soon as the plants are set up. • The systems could also be partially produced in Cuba. This would be especially possible if providers of wind turbines choose Cuba as a starting point towards entering the markets in Central America. • The proposed project would suit the Clean Development Mechanism (CDM) well. Cuba could use the CDM to have part of the resulting CO2 certificates credited to it. This could create considerable income for the state. • The agreement of a leasing fee could allow communal organizations and regions to benefit from the proceeds. • In combination with (further) training programs, which could be financed by international organizations, Cuba could begin setting up its own wind industry or further develop the existing production of small systems. The incentives for offgrid wind power would be especially interesting for areas not connected to the grid. One remaining risk, however, is the world market price for crude oil: investors would run the risk that oil prices may fall. In this case the investments might show losses. However, world market prices cannot be expected stay low for long; rather, they will increase in the mid to long term anyway. In that case, the plant would increasingly yield a surplus. 3. TOURISM LEVY FOR RURAL ENERGY The concept of “sustainable tourism” is not new. But it has usually been limited to environmental issues and, occasionally, cultural aspects. Here, however, sustainable tourism is not only taken to mean environmental friendliness, but also an improvement of the local social and economic structures. This tourism counterbalances the standards of living between the industrial nations and the Third World, on the one hand, and between regions within the developing nations on the other. This balance is to be achieved with a tourism fee charged per person/night. Mostly paid by foreign tourists, this

surcharge is to be devoted to financing rural electrification in Third World countries, thus also benefiting rural development overall and improving the environmental standards in tourist hotels. Tourists will also benefit from this surcharge, as it will help reduce tensions within society. A calming of tensions will indirectly increase the safety of tourists, making travel destinations even more attractive. Some tourists may even have a better conscience with the knowledge that their vacation is a contribution to sustainable development. A proposal to realize such a concept in Mexico was made. For this concept to work, the fee will have to be designed as a dedicated levy rather than a general tax. In other words, the revenue from these levies must be used for a specific purpose. This direct allocation is necessary for two reasons: first, to ensure that the funds collected can be used for a specific purpose; and second, to be able to “sell” the idea to tourists. The latter goal is especially important for the acceptance of the levy. If the levy can be communicated correctly, it will not reduce the demand for tourist resorts in Mexico, but rather attract even more tourists. 3.1. Basic data on the importance of tourism for Mexico Tourism is one of the most important economic sectors in Mexico, making up 9,4 % of the gross national product. Mexico is a “tourism giant” even on an international scale. In 2000, Mexico was the 8th most popular travel destination, with 20,6 millions arrivals. The tourism sector is the largest “employer” in Mexico, offering some 3,2 million jobs. Some 9,5 % of all employees work in this sector. In addition, the tourist sector will probably grow faster than any other industry in Mexico in the next few years. The Word Travel & Tourism Council forecasts a 7,7 % annual growth rate (in terms of constant prices) up to 2012. (World Travel & Tourism Council, 2002) 3.2. Specifics and adaptation of the proposal to Mexico The taxes and levies used in the tourist sector fit into two categories: A) Directly charged to tourists • Entry/exit taxes • Air passenger duty • Hotel/accommodation (bed-night tax) • Restaurants (VAT) B) Charged to tourism business • Fuel tax • Duties on the import of tourist equipment • Property and corporation taxes In this proposal, the charges are based on the number of nights spent. It is also proposed that the levy be based on the ranking of the hotel. For example, the surcharge for a one-star hotel might be US$ 0.50 per night, while the surcharge for a five-star hotel would be US$ 3.

This type of levy has several advantages over other types: • The levy takes the various income levels of the tourists into account. • The levy is based on the degree at which tourists use resources (beach, infrastructure, sights). • The levy is mostly paid by foreigners. As they do not generally vote in the country, little resistance to such a levy is expected outside of the tourist sector. Other countries already use a levy on tourism or tourist tax to a considerable extent. For instance, Cuba charges an entry and exit fee of US$ 20 each way. The entry fee for the Seychelles is US$ 90 per person. 3.3 Inflow of funds and proposed use of funds A basic model calculation was created to determine the inflow of funds. Here, it was assumed that the roughly 20 million tourists that visit Mexico each year spend an average of 5 days in a hotel. The total inflow of funds from this surcharge is estimated at US$ 160 million per year based on the distribution of tourists across hotel categories (one to five stars) in table 2. Table 1: Revenue based on the proposed surcharge

The average surcharge each tourist has to pay only amounts to US$ 8. In terms of the overall costs of the trip, this fee will probably not even amount to 1 % in almost all cases. The following structure is proposed for the use of the tourist levy: • The biggest part should be used to improve the access to sustainable energy in rural and lowincome areas. It could be used to subsidize the SHS which will be installed in off-grid areas. • About a quarter of the incoming money should be used to finance programmes to “green” the tourismsector (efficient energy and electricity use, solar energy for heating water, water-saving technologies, waste management) • Another part could be used to finance demonstrations of renewable and efficient energy supply at the most visited points of the country. • Last but not least, it would be an important task to teach the workers in the tourism-sector about environmentally friendly behaviour.

• As the tourism market can be expected to continue to grow6, the revenue from this levy would also increase. • The average burden on individual tourists is slight and will hardly be noticeable in many cases.

rural electrification 10%

"greening" hotels

15%

demonstrating sustainable energy 25%

50%

capacity building

Figure 3: Use of inflow of funds from surcharge

3.3 Effects on rural electrification The original costs of a Solar Home System (SHS) are around US$ 800. Such a system can power three energysaving lamps, a radio, and a television (< 20 W of consumption). With a budget of around US$ 80 million annually and a subsidy quota of 70 % of the original costs, some 150.000 households or 750.000 people could be provided with solar power systems annually. In other words, the tourism levy could provide power to all off-grid households in Mexico (some 1 million, or 5 million people) within around 7 years. In most cases, SHS would be used, but in exceptional cases other regenerative sources of energy or hybrid systems would be used. In addition, tourism could be made more environmentally friendly and attractive. 3.4 Pros and cons of a tourism surcharge One argument against the tourism levy is that the price elasticity of demand is not known and that the elasticity of demand might lead to a reduction in Mexico’s overall income from the tourism industry. In many cases, however, the attractiveness of the tourist resort would be much more important than the amounts charged in this levy. An overview of the taxes in various cities illustrates this: Although London charges the highest taxes, more than 25 million people visit it every year. Based on a defined product mix (rental car, hotel, expenditures in restaurants, etc.) and a stay of 5 days and four nights, a tourist in London pays US$ 341 in taxes alone. (Durbarry 2000) Another argument against a tourism levy is the collection costs it entails. In addition to the above arguments, there are three other aspects that speak in favour of a tourism levy: • The political acceptance of a tourism levy is expected to be great. Except for the tourism industry itself, there probably will not be any major interest groups that fight such a levy as the money will basically be paid by foreign tourists.

4. CONCLUSIONS Many developing nations depend on oil imports for their energy supply. In addition, the power plants used for the generation of electricity are often very inefficient. Thus, the situation of energy industries in many of these countries can be expected to resemble the situation in Cuba. The proposed reimbursement model for funding wind energy plants is especially interesting for developing nations as their economy is not burdened and the entire risk lies with the private capital investors. An initial rough calculation showed that such a concept can be economically viable, i.e. the investor could obtain a reasonable profit with only a moderate price increase assumed for crude oil. The advantages are multi-fold: dependence on oil imports and the risk of price fluctuations based on the world oil market would tend to decrease, the environment would benefit from reduced emissions, and power plant capacities would expand without additional costs. This insight does not only apply to Cuba, but to many other countries as well. Therefore, two conditions have to be fulfilled: High electricity generation costs through the operation of inefficient power plants with crude oil, as well as good wind conditions. In such a case, modern wind power plants can compete against conventional electricity generation. With a reliable business environment for private investors, electricity generation could be more environmentally sound without resulting in a financial burden for the countries. The tourism levy model for Mexico revealed that even a small levy could further the electrification of rural areas significantly. The concept of a tourism levy could also be used in all countries where tourism is one of the main sources of income. The levy would be used as an instrument of closing the urban/rural gap in Third World countries, thus also reducing social tensions. The target countries and the tourists would both benefit from the redistribution of wealth from industrial to developing countries that the tourism levy entails. For more information, please visit the web-page: http://sepco.ises.org. REFERENCES Durbarry, Ramesh: Tourism Expenditure in the UK: Analysis of competitiveness using a gravity-based model, Nottingham 2000

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The World Travel & Tourism Council forecasts worldwide growth of 12 % annually up to 2012.

EC 2001 European Commission: Community guidelines on State aid for environmental protection. Official Journal C 037, 0003-0015 G 8 Renewable Energy Task Force, Final Report 2001. Hennicke, Peter: Travelogue from the informational travel under the invitation from the Friedrich-EbertFoundation, February 2000 Valdes, Dr. Antonio: Cuba´s Transition away from Fossil Fuels; in Stockholm Environment Institute – Newsletter of the Energy Programme, June 2000 World Travel & Tourism Council (2002): Mexico. The impact of travel & tourism on jobs and the economy – 2002 plus special report on September 11th impacts ACKNOWLEDGEMENT This project was funded by the German Federal Ministry for the Environment, Nature Conservation and Nuclear Safety (BMU).