As part of a UK government-funded project to support the Philippines power sector stakeholders navigate the shifts, risks and opportunities associated with the energy transition, the Carbon Tracker Initiative (CTI), in collaboration with the Institute of Energy Economics and Financial Analysis (IEEFA) and the Institute for Climate and Sustainable Cities (ICSC), have hosted a series of stakeholder events to gather the views from power sector stakeholders including the recent engagement in July. These blog post summarises various viewpoints and their implications for the project.
About the project
The project has three objectives:
- Gather views from stakeholders on the inflection points of new and existing power generation investments, comparing the economic cost and financial liability of import-dependent coal and inflexible power in the face of cheaper alternatives such as renewables.
- Propose recommendations for policymakers to encourage a flexible, efficient, and 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.
The stakeholder-centric process of project aims to secure consensus among developers, investors, policymakers and civil society about the most suitable approach to measure and manage energy transition risk in the Philippines. The latest consultation held in July focused on the implications of Covid-19, stranding risk in the power sector, as well as the appropriate strategies to respond to both issues.
Implications of COVID demand destruction
The COVID-19 pandemic has had a profound impact on energy markets in 2020. According to the International Energy Agency (IEA), energy demand declined to a level not observed since the second World War. The Philippines has been no exception to this trend, with the Department of Energy (DOE) revealed that electricity demand fell by 30% in Luzon, 17% in the Visayas, and 25% in Mindanao over the first COVID-19 lockdown.[i]
COVID-19-related demand destruction provided a glimpse into the future when variable wind and solar make up a higher proportion of power supply. The dramatic drop in power demand also revealed a lack of flexibility in the Filipino power system. To date, regulations underpinning power market design in the Philippines tend to incentivise generation capacity over system value. The DOE targets a power mix of 70% “baseload” capacity, 20% “mid-merit” capacity, and 10% “peaking” capacity.[ii] Moreover, according to the DOE, 80% of the country’s baseload capacity is deemed inflexible.[iii]
As the demand constraint from COVID-19 hit, more flexible power generation technologies were needed. This resulted in a drop in inflexible coal power from 70% to nearly 50% during the first lockdown. According to data from National Grid Corporation of the Philippines, coal generation was responsible for 60% of unplanned outages on the Luzon grid from 9-22 May 2020. This dynamic has cost implications for consumers, as the forced outages are part of a reimbursable cost payment in coal power supply agreements (termed PSAs), and therefore costs incurred are charged to end-users.
The Philippines government is considering several reforms to improve grid flexibility and incorporate more renewable energy, including a moratorium on inflexible power and a green auction by 2021.
Measuring and managing energy transition risk
Excluding the short-term impacts of COVID-19, transition risk in the Filipino power sector will likely materialise when the levelized cost of firm or dispatchable renewable energy becomes less than levelised cost of fossil power plants, including high efficiency coal plants. At this point new sources of power generation ought to be domestic renewable energy technologies, such as wind and solar, rather conventional thermal technologies. Considering the current and growing risk of coal stranded assets in the Philippines and realization of stranding from the largest utility company, new build coal plants are making less and less economic or financial sense.[iv]
The Philippines is now on the cusp of this transition. Regional variations and local contexts can of course affect the speed of this transition, especially in power markets where regulations are often the key driver of investment and operational decisions. Regarding the Philippines, there are a number of variables that may speed up or slow down the transition on both the supply and demand side, including the rapid technological development driving low-cost system opportunities, which can now meet or undercut the price of power from the electricity grid, and cannibalize the market for coal-fired generation.
Signs of change
Declining capacity factors for coal has led the Manila Electric Company (MERALCO) to recognize non-performing stranded risk through better tariff management, such as carve-out clause that permits curtailment – meaning MERALCO can opt to buy less power under certain conditions.[v] Moreover, there are regulatory improvements such as the modernization of the wholesale spot market that removes the automatic nomination of coal in dispatch.
According to analysis from IEEFA, over 100 banks and insurers have announced their divestment from coal mining and/or coal power.[vi] This makes financial sense given the deteriorating economics of fossil fuel power and the fact that asset owners and managers have a fiduciary duty to take into consideration financial risks. As capital markets begin to manage energy transition risks more actively, it will be essential for governments to put in place policies that incentivise competitive and domestically secure power sector development. Moreover, we are already seeing leadership by the financial sector regulators in the Philippines. Specifically, the Philippines’ Central Bank’s Sustainable Finance Framework includes transition risk such as stranding risk – bank’s will have to submit a 3-year work plan to address these risks. This complements the SEC’s mandatory ESG reporting for publicly listed companies for 2019 onward.
Conclusion and next steps
Amid COVID-19 and its subsequent recovery, there is an opportunity for the Philippines to improve its power system by prioritizing system flexibility and resilience instead of a solely focusing on baseload generation. This requires recalibrating relative prices as well as accurately pricing risks and externalities. A report with report recommendations for policymakers and investors will be published in late October.
Written by Matt Gray, Sara Ahmed (IEEFA) and Aurore Le Galiot.
[iv] Stranded assets are now generally accepted to be those assets that at some time prior to the end of their economic life (as assumed at the investment decision point), are no longer able to earn an economic return (i.e. meet the company’s internal rate of return), as a result of competition from cheaper sources, changes associated with the transition to a low-carbon economy (lower than anticipated demand / prices). Or, in simple terms, assets that turn out to be worth less than expected because of changes associated with the energy transition. https://carbontracker.org/terms/stranded-assets/