Electricity sector: Without investment we will be in the dark again

From the fact the Sri Lankan developers of wind farms source many of the needed inputs from India, it should be 

evident that the eco system of supportive manufacturers is well established there and not here

The 13-hour power cuts two years ago should have educated us on the importance of reliable power supply. But we forget after two weeks, it is said.

What is being done to ensure that will not happen again, including lessening dependence on imported fossil fuel, may not be perfect. But it is important to call out egregiously misguided criticisms. If such attacks succeed as they did 20 years ago, we will continue to suffer the consequences of a bad legal framework, resulting workarounds, and underinvestment in generation, transmission, and distribution. The blocking of new baseload plants from the 1990s served no one’s interests, other than perhaps of the so-called diesel mafia. We all paid for that. We continue to pay. 

The CEB engineer’s union does not like the phrase “reasonable return” being included in the new Sri Lanka Electricity Act. An eminent public intellectual, Rohan Pethiyagoda, bemoans the fact that a unit of electricity produced by the wind power facility proposed by Adani will cost more than wind-produced electricity in the US and in India. 

Both positions illustrate the inability of those engaged in public discourse in Sri Lanka to understand the centrality of investment, and ignorance of (or intentional disregard of) the necessary conditions for inducing private investment. It was understandable in the Mahaveli days that people did not pay attention to investment and had no appreciation of the different costs of money invested in different contexts. 

The entire upfront cost or investment in the Victoria Dam was Rs. 9,000 million (in 1980’s money) including a grant (a gift) of Rs. 6,557 million from the United Kingdom. Grants of this magnitude were rare even then. They are non-existent now. The last one we were offered was $ 500 million from the US Millennium Challenge Corporation. Dr. Lalithasiri Gunaruwan, who recommended declining that free money, is among those objecting to the new law and foreign investments in the power sector.

In recent times, the practice was to finance all major public investments through loans with little concern for repayment. It was assumed that Treasury would make the repayments, even for loans taken with Treasury guarantees. Treasury could not, and we ended up in queues. 

Investment for wind power

There is no Santa Claus; no Maggie Thatcher to gift an entire dam through a grant. The considerable investment necessary to convert the wind energy barrelling down along the Mannar Coast must come from one of three sources: the consolidated fund of the Government of Sri Lanka, loans, or private investment. 

There is no money in the consolidated fund, as everyone knows. Most tax and non-tax revenues go for salaries, pensions, and welfare payments. When interest payments are added, there is nothing left. 

The recently commissioned CEB wind power plant in Mannar was built with a loan of $ 160 million from the Asian Development Bank. In addition, there was a local rupee contribution equivalent to $ 56.7 million. The ADB loan is backed by a Treasury guarantee, valid from November 2017 to September 2037. The IMF Agreement places strict limits on Treasury guarantees. No one will lend to the CEB without guarantees. Therefore, loans are no longer an option.

That leaves only the third option, private investment. And those who make private investments do so expecting a reasonable return, the term disliked by the CEB Union. Reasonableness of the return is pegged to perceptions of risk. The higher the risk, the higher the expected return. 

Electricity is generated by a horizontal axis wind turbine having an upwind rotor with three blades, attached to a nacelle mounted atop a tall tubular tower. The tower will be about the height of the HNB building in Colombo. It has to be imported, transported to the site, and raised using specialised cranes brought from India. The turbine, the blades, and the equipment in the nacelle including the brakes and electronics, are also imported, as are the radars to detect birds and the equipment to respond to excessive wind. So, it is not just money that is needed. What is needed are dollars.

The proposed 484 MW wind power plants in Mannar and Pooneryn by Adani is expected to require an investment of over $ 700 million. That is more than the declined MCC grant and less than the $ 1.35 billion loan taken to build the 900 MW Norochcholai coal-fired power plant in 2006.  The investor can raise funds in two ways: equity or debt. Given the size of the Sri Lankan economy and the stock market, it is unlikely that a domestic investor can raise the funds internally. The well-endowed Adani Group has indicated its willingness to invest, raising the funds both internally within the group and also as debt. It has already spent considerable resources obtaining multiple clearances and approvals.

Even when raising funds internally, risk is assessed, and the rate of return is factored in. A conglomerate like Adani has businesses in multiple countries and in different industries. Internal funds will be released only when the board is satisfied that the return on the investment is adequate. Adani is taking on debt for this investment. Given Sri Lanka’s low country ratings (SD from S&P and Ca from Moody’s), the country risk premium will be high. India has ratings of BBB- from S&P and Baa3 from Moody’s. Cost of capital will be lower in India. 

When investment is front loaded as is the case with wind power, the returns occur over the 20 to 30-year lifetime of the investment. Whatever price is negotiated at the start, the actual yield can be affected by many factors outside the control of the investor over the duration of the project. Taxes may be imposed, exchange rates may crash, restrictions may be placed on repatriation of funds. These are not hypotheticals; they have happened in recent memory. All this adds up. This may be the rationale for reasonable return being specifically mentioned in the bill.

The cost of capital for wind power in Sri Lanka cannot be directly compared with those for investments in the US and in India. When the cost of capital is significantly high, the unit prices of electricity will also be high. Therefore, it is fallacious to compare Sri Lanka with India and the US. But there are more factors at play.

Additional costs in Sri Lanka

The electricity that is generated in remote locations like Mannar and Pooneryn must be brought to the grid, and then to where the consumers are. The Mannar CEB plant required a new substation at Nadukudah and transmission lines to Medawachchiya and Vavuniya. In the case of private wind and solar farms in Sri Lanka, investors are required to include the costs of building the transmission line to the designated grid interconnection points. This is specifically provided for in the new bill.

When comparing unit prices of wind-generated power, these differences must be accounted for. In the case of the Mannar location, it is most likely that the capacity of the transmission lines built for the CEB plant will be supplemented, resulting in lower costs for the investor. In the case of Pooneryn, it may be necessary to build from scratch. Location decisions are not solely based on load factors but include additional costs like these. Transmission costs must be investigated before criticisms of location decisions are made. If the Mannar location, close to the existing CEB plant, is excluded because of concerns about migratory birds as Pethiyagoda suggests, the unit costs that have to be paid for wind-generated electricity will also go up, banging up against his other criticism. These are tradeoffs.

India is a big economy which enjoys scale and agglomeration advantages. From the fact the Sri Lankan developers of wind farms source many of the needed inputs from India, it should be evident that the eco system of supportive manufacturers is well established there and not here. Vestas, the supplier of the equipment for the CEB plant in Mannar, has been in India since 1997 with sales and services, some manufacturing and R&D in the Chennai area. It manufactures turbine blades in Gujarat. There is competition. This naturally results in lower costs in India. It follows that unit prices for consumers would also be lower in India.

As part of the Indian government’s encouragement of renewable electricity, it has exempted many if not all wind projects from the multiple approvals, including environmental impact assessment. We can be happy that environmental impact assessment is considered non-negotiable in Sri Lanka. But we must then accept the resulting impacts on project approval time and associated cost escalations. If we want lower prices, we must reduce the complexity of the approval procedure as India has done. It is not possible to have both.

Ideal versus reality

I would love to see simplified and transparent procedures wherein the Sri Lankan state sets up wind and solar farm zones with environmental and other approvals and the road and power transmission infrastructure already in place. Such onshore and offshore sites can be marked out and auctioned as has been done in the US and elsewhere. We would then be able to have greater comfort about the cost elements that form the basis of the price negotiations that are now ongoing. Prospective investors are also likely to prefer this.

Land acquisition and compensation will be easier if those at the provincial and local-government levels are given authority along with shares of the value that is created. Today, all value flows to the centre creating incentives for foot dragging, if not obstruction, by those close to energy production.

But our conditions are far from ideal. We do not have the luxury of creating the ideal conditions beforehand. We need to get private investment mobilised as quickly as possible to avoid load shedding (and/or high-cost emergency power) when the economy starts growing again. The alternatives to investments in renewables are expensive and harmful to the environment. Exclusion of foreign investments in electricity, as recommended by Gunaruwan and the JVP, will not give us energy sovereignty. It will increase our dependence on expensive and dirty imported fossil fuel.

The reality is that we have to work with willing investors such as Adani while setting in place the preconditions for auctions. We should not advance fallacious claims such as wind-based electricity prices being high relative to prices in large markets with different rules. The conversation should continue, but in a more sober, evidence-based manner. We are very good at blocking things. But unless we also allow things to be built, we will continue to be saddled with a dysfunctional electricity sector.