Anna Tikhonova's Blog

It's economics, stupid!

June 5, 2017
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Today, 24% of global electricity is generated from RES, and this number is expected to reach about 60% by 2040. Nevertheless, despite the active growth in global capacity, RES role in the power sector is challenged by the rigidity of current grid systems, distortions of power prices following the integration of renewables, as well as their own limitations (in terms of both,- financing and technology) that are highly sensitive to market design and policy support. Consequently, in the atmosphere of the post-COP21 consensus, one might wonder whether the future in which electricity is produced from renewable sources can be envisaged at all. By the end of 2015, 110 countries adopted policies supporting renewable energy, with renewable share in power generation ranging from 10% to 97.9% on a country level, and reaching 100% to 200+% on a local community level (eg. Bavarian Effelter). By looking at these numbers, one might want to fully part ways with any doubts whether RE can become the lynchpin of the power sector. However, the most important question, is not whether green power generation is possible, but whether it is possible where it is needed the most. For this reason, it is still interesting to concentrate on the Asian region, whose China and India account for most of the world’s emissions. Thus, in both of these developing economies increasing shift to renewables indeed can become a real game-changer helping resolve a triple challenge in meeting growing demand for electricity. First of all, unlike in OECD countries, their electricity consumption is still driven by GDP and population growth, meaning that power generation will be the fastest growing sector in primary energy consumption. Secondly, while being seen as key energy consumers in the future, these countries still have to bridge the gap by providing 44% of increasingly urban population with access to electricity. And, last but not least, the necessity to timely expand capacity that supports power generation is complicated by the socio-political rationale to cut pollution. The reason why it’s worth concentrating on the solar installations is twofold. One the one hand, the share of solar compared to other renewable capacities installed in these countries is rather minor, i.e. around 16% in each of them. On the other hand, following the political discourse of China’s President Xi and India’s PM Narendra Modi, solar power is destined to become the lynchpin of these countries’ strategies to expand their shares of RE in power generation from today’s levels of 24.7% and 14.1% respectively. Following an expected 60% cost reduction of solar PV by 2040, solar panels will be able to aid India’s electrification by overtaking the role of current distribution companies that are making losses due to inefficiency of transmission lines and inability to enforce and monitor electricity payments by consumers. A change in cost-structure will spread PVs not only across the utilities but will make them citizen-owned, allowing for private roof-top installations not connected to the grid. While solar PV has the smallest share in the Indian renewable portfolio (around 7GW in 2016), Indian policy-makers set a goal of having 100GW by 2020. This can hardly sound realistic, despite the fact that India already tried showing it commitment by more than doubling PV capacity in the matter of 18 months. According to BNEF, constructing all necessary infrastructure by 2020 will cost India 100bln$ for 100GW, i.e. a scary number, given that the high cost of debt as well as possible currency devaluation can increase this number at least by a third. However, the Indian government is trying to put in place an interesting policy that legally incentivizes companies to tap on their social corporate responsibility budget not only in order to construct off-grid sector but to buy renewable power purchase obligations. The government also designed special infrastructure funds that consist of foreign and domestic investors who operate through special purpose vehicles and provide consumer loans in a risk-mitigating asset structuring. It is still hard to judge whether India will be able to fulfill (or, rather, approach?) its ambitious goal, however, 66% of finance seems to have been already secured, whereas the overall conditions for solar are very plausible: the part of the country that is mostly targeted by the state policy (i.e. the one with the lowest rate of electrification) has the highest population density and the highest irradiation rate. Altogether, these conditions not only decrease the forecast error for the centralized dispatch but allow for a more efficient use of supporting hydro/diesel capacity, rationalizing investment in expensive net metering, while making the pay-as-you-go business model also available. There is also a great number of wind producers who shifted to solar, while introduction of cross-subsidies and high tariffs allows privately built PVs to collect cash following their installments. And even though the process of shifting from diesel to solar on the local level could not work immediately, today, when the income per capita of an Indian household continues to grow, 75% of all roof-top PVs are citizen-owned. Unlike India, who has to overcome financing problems due to the high import duties on foreign technology as well as the highest cost of capital in the region, China is the net producer of PV cells. At the same time, its power sector growth started slowing down, what is, as strange as it might seem, accompanied by increase in annual capacity build-up coming both from coal and renewables. While China is de jure supporting decarbonization, it is de-facto building a new coal power plant every week, what makes it have an average 30% reserve margin of capacity across the country (whereas in the US, for instance, it’s below 15%). On the one hand, such a mismatch (when coal use occupies 2/3 of the energy mix and only keeps growing ) makes experts doubt the possibility of the transition to renewables. However, on the other hand, the fact that there is a new power plant popping up each week does not necessarily contradict the Chinese pivot to RES. Unlike solar farms, which can be constructed in a friction of the year, it takes at least a few years to build a coal plant. So what we are witnessing right now is likely to be the result of the previous policies and former consensus that was based on the 2014’s coal prices, inexistence of COP-21 Accords, and expectations of a growing demand for power. And another reason why coal is curtailing renewable generation (making solar plants run only at 10% of capacity factor) is Chinese heritage of the communist 5-year plan policy. Indeed, at the time the 12th 5-year energy policy plan was confirmed in China, renewable power did not yet kick in at fool bloom. That is why, traditionally, instead of the generator dispatching on the merit order, in most Chinese provinces, system operators work according to principles that allow each coal-fired generator to achieve a targeted number of annual operating hours, as determined in an annual generation output planning process. And especially after the collapse of the coal price (that went from 84$ per tonne to 36$), Chinese policy was framed in a way to ensure that all coal generators could earn their return on investment, so the operating hours were allocated evenly across all generators. That is why today, this growing overcapacity in coal-fired plants has been putting a downward pressure on operating hours for all generation, most of which, traditionally, operate “point-to-grid” instead of “grid-to-grid.” Despite the number of advantages as well as the decisiveness of the Asian Development Bank to provide half a billion dollars in order to scale India’s and China’s solar installation, the underlying question is about the policy framework. There is a number of countries, such as the US, Span, Germany or Czech Republic, that already removed tax credits for solar generation, cutting down their FIT, however, it is still unclear under which exact framework China and India will carry out their investment cycle.
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