Presensation For IARU Climate Change Congress


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This presentation was given at the IARU Climate Change Congress titled Climate Change: Global Risks, Challenges & Decisions in Copenhagen, Denmark in March 2009.

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Presensation For IARU Climate Change Congress

  1. 1. Assessing the financial viability of small-scale wind turbines in South Africa under different scenarios Brendan Whelan Masters of Science in Carbon Management University of Edinburgh
  2. 2. Background <ul><li>Aim of this paper is to assess the investment case in small-scale wind turbines for electricity consumers in South Africa in four different financial scenarios </li></ul><ul><li>Investigate whether this technology has a role to play in decarbonizing South Africa’s energy supply and providing greater energy security to consumers </li></ul><ul><li>Adaptation is often highlighted as the fundamental response to climate change in Africa </li></ul><ul><li>The SA case is a different case as it is a big emitter with a high emissions intensity </li></ul><ul><li>The country needs to move towards sustainable energy solutions </li></ul><ul><li>SA is only starting to capitalize on opportunities in carbon markets </li></ul>
  3. 3. Outline <ul><li>Background </li></ul><ul><ul><li>Opportunities and barriers relevant to the energy market in SA </li></ul></ul><ul><ul><li>Resource and market potential for small-scale wind turbines in SA </li></ul></ul><ul><li>Discussion of theoretical framework </li></ul><ul><li>Discussion of methodology </li></ul><ul><li>Discussion of results under four scenarios </li></ul><ul><li>Policy implications </li></ul><ul><li>Conclusion </li></ul>
  4. 4. Background <ul><li>SA’s significant carbon emissions: danger it may have to play catch up </li></ul><ul><li>SA is well endowed with renewable energy (RE) resources but currently only contributes to 1% of consumption </li></ul><ul><li>Government target of 10 000GWh (equivalent to 4% of projected consumption): currently off track </li></ul><ul><li>Energy security: window of opportunity </li></ul><ul><ul><li>Electricity supply constraints: power outages and load shedding </li></ul></ul><ul><ul><li>Recent hikes in electricity tariff and fossil fuel prices </li></ul></ul><ul><li>The growth of microgeneration technologies in international markets </li></ul><ul><li>The most significant barrier: cheap electricity in SA </li></ul>
  5. 5. Background: wind specific drivers and barriers <ul><li>Wind power: one of the most economic RE alternatives </li></ul><ul><li>Cost of wind power continues to fall through growing economies of scale and technologically is continuously progressing </li></ul><ul><li>2004 World Energy Assessment Report estimates </li></ul>
  6. 6. Backdrop: wind specific drivers and barriers <ul><li>Significant wind resource potential in South Africa especially along the coastline and areas along the escarpment </li></ul>
  7. 7. Backdrop: wind specific drivers and barriers <ul><li>Largely unexploited; current generation of 32,000MWh </li></ul><ul><li>Estimated that South Africa could meet 5-6% of demand with economically feasible wind generation </li></ul><ul><li>Notable potential in areas where supply networks are undeveloped </li></ul><ul><li>Small-scale wind turbine market in South Africa is in its infancy and fragmented </li></ul><ul><li>Barriers: </li></ul><ul><ul><li>lack of technology awareness </li></ul></ul><ul><ul><li>high initial capital costs </li></ul></ul><ul><ul><li>difficulties in accessing financing </li></ul></ul><ul><ul><li>absence of support framework </li></ul></ul>
  8. 8. Theoretical framework <ul><li>A range of methods were considered: Supply Curve Analysis, the Payback Period, the Net Present Value (NPV), the Internal Rate of Return (IRR) and Cost-benefit Analysis (CBA) </li></ul><ul><li>Internal Rate of Return (IRR) method: widely accepted method preferred for its relative accuracy and suitability to the decision-making process surrounding the acquisition of assets </li></ul><ul><li>IRR is the discount rate which delivers a net present value of zero on future cash flows </li></ul><ul><li>The rate at which returns on an investment outweigh the opportunity cost. The opportunity cost is the returns that would have been earned on an alternative investment </li></ul><ul><li>The hurdle rate or weighted average cost of capital (WACC) </li></ul><ul><li>IRR > WACC to be viable </li></ul><ul><li>All other things equal, the investment with the highest IRR is the most attractive investment </li></ul>
  9. 9. Methodology - Overview of model <ul><li>Financial analysis was performed for a 1kW and a 5kW wind turbine </li></ul><ul><li>The viability of a small-scale turbine was investigated in four scenarios: </li></ul><ul><ul><li>For the ten windiest locations in South Africa in a market with no support from any financial mechanisms </li></ul></ul><ul><ul><li>In a market with a tariff subsidy on top of standard tariff rates </li></ul></ul><ul><ul><li>In a market with a capital subsidy </li></ul></ul><ul><ul><li>In a market with revenues from the sale of carbon credits </li></ul></ul>
  10. 10. Discussion of cost value estimates <ul><li>Assumptions: </li></ul><ul><ul><li>i) full value of the initial capital cost investment is incurred by the start of period one </li></ul></ul><ul><ul><li>ii) costs for the remaining periods are equal to the annual O&M cost </li></ul></ul><ul><li>Value for initial capital costs </li></ul><ul><li>Value of the annual O&M cost </li></ul><ul><li>O&M costs likely to be higher in SA: US has a far more developed small-scale wind turbine market </li></ul>
  11. 11. Discussion of benefit value estimates <ul><li>Financial analysis focuses on the viability of small-scale wind turbines for consumers who are grid-connected </li></ul><ul><li>Yearly benefit = amount the consumer saves in generating their own electricity instead of purchasing it from the grid </li></ul><ul><li>+ annual revenue from a tariff subsidy if applicable </li></ul><ul><li>+ revenue generated from the sale of carbon credits if applicable </li></ul><ul><li>Savings = annual generation harvest multiplied by the tariff rate </li></ul>
  12. 12. Discussion of benefit value estimates: tariff rate & subsidy <ul><li>Tariff rate: reflects the most recent tariff prices </li></ul><ul><li>Tariff inflation: assumed to be 10% per annum over the lifespan of the wind turbine </li></ul><ul><li>Tariff subsidy: take the shape of a Power Purchase Agreement which will pay the small-scale wind turbine owner an additional rate per kWh of electricity generated </li></ul><ul><li>Annual revenue from a tariff subsidy = product of the output of a turbine over a year and the value of the tariff subsidy </li></ul>
  13. 13. Discussion of benefit value estimates: power performance curve <ul><li>Annual harvest is calculated with the use of a power performance curve formula </li></ul><ul><ul><li>P = power output; </li></ul></ul><ul><ul><li>ƿ = the air density ; </li></ul></ul><ul><ul><li>A = rotor area covered by the turbine’s rotor blades; </li></ul></ul><ul><ul><li>V = cube of the mean hourly wind speed; </li></ul></ul><ul><ul><li>C p = the power coefficient of the rotor </li></ul></ul><ul><li>Power output is then annualized </li></ul>
  14. 14. Discussion of benefit value estimates: carbon credit revenue <ul><li>Carbon credit revenue: product of the total carbon savings and the negotiated price of the carbon credit </li></ul><ul><li>Risk of projects can vary greatly thus credits are traded at a broad range of prices </li></ul><ul><li>Validated baseline emissions level for the national grid = 0.000963 tons of CO 2 /kWh </li></ul>
  15. 15. Results: Scenario I <ul><li>Case where there is no support from any financial mechanisms </li></ul><ul><li>A mean annual wind speed in excess of 8m/s is the minimum wind speed required for a 1kW turbine to be viable at any location </li></ul>Site Annual mean wind speeds IRR for 1kW turbine (38.34c/kWh) IRR for 1kW turbine (45.05c/kWh) IRR for 5kW turbine (38.34c/kWh) IRR for 5kW turbine (45.05c/kWh) Gains Castle 13.94 52% 60% 48% 55% Springbok 8.27 15% 17% 14% 16% De Aar 6.88 9% 10% 7% 9% Langebaan 6.88 9% 10% 7% 9% Simonstown 6.65 7% 9% 6% 8% Cape Town 6.63 7% 9% 6% 8% Koningnaas 6.2 5% 7% 4% 6% Ixopo 5.82 4% 5% 3% 4% Geelbek 5.62 3% 4% 2% 3% Noupoort 5.6 3% 4% 2% 3%
  16. 16. Results: Scenario II <ul><li>Tariff subsidy granted to the small-scale turbine owner by means of 20 year long PPA </li></ul><ul><li>What level of tariff subsidy surplus to the standard tariff charge would be required by an investor in order to achieve the WACC of 15% at any location given a specific wind resource? </li></ul><ul><li>For this scenario an annual mean wind speed of 5m/s will be used as a benchmark </li></ul>
  17. 17. Results: Scenario II <ul><li>For a 1kW turbine a tariff subsidy of R1.30 per kWh on top of the standard tariff would make the investment viable </li></ul>
  18. 18. Results: Scenario II <ul><li>For a 5kW turbine a tariff subsidy of at least R1.40/kWh in surplus to the standard charge is required </li></ul><ul><li>Results confirm that coal-based electricity in South Africa is rather too cheap for renewable energy sources such as wind to be competitive </li></ul><ul><li>The major reason why coal-based electricity is cheap is the excessive support which the power utility company has been given by government </li></ul>
  19. 19. Results: Scenario III <ul><li>The case for a capital subsidy grant </li></ul><ul><li>For an increase in the level of subsidization on the initial capital investment there is an exponential growth in the IRR for a 1kW turbine </li></ul><ul><li>A capital subsidy grant of at least R33 000 is required by the owner of a 1kW turbine </li></ul>
  20. 20. Results: Scenario III <ul><li>5kW turbine will require a capital subsidy grant around R35 000/kW (over 70% of the initial capital cost) in order to generate a rate of return greater than WACC </li></ul><ul><li>Capital subsidy grants theoretically have the potential to enhance the viability of small-scale turbines on a broad scale </li></ul>
  21. 21. Results: Scenario IV <ul><li>The case where a small-scale turbine owner has secured a twenty year contract of sale for forward priced carbon credits from a willing buyer in the carbon market </li></ul><ul><li>Assumptions: no transaction costs and additionality requirements for CDM are met </li></ul><ul><li>Revenues generated from carbon credit sales, even at prices at the top end of the market, will be insufficient </li></ul><ul><li>Prices of around R2,700 per tCO 2 saved by owners of 1kW turbines and exorbitant prices of around R3150 per tCO 2 saved by owners of 5kW turbines will be required </li></ul><ul><li>The annual avoided emissions of equivalent CO 2 for the turbines are low </li></ul><ul><li>Thus the revenues from sales of carbon credit are outweighed by the large initial capital investment </li></ul><ul><li>Cash flows of small-scale wind turbines are not highly elastic to changes in carbon credit prices </li></ul>
  22. 22. Policy implications of the financial analysis <ul><li>Only likely to be a viable investment in select locations in South Africa where mean annual wind speeds are high </li></ul><ul><li>Financial analysis demonstrates that the viability of small-scale wind turbines can be enhanced notably if the investment is supported by financial mechanisms </li></ul><ul><li>If this technology is going to be employed on a significant scale in SA it is likely that it will need to be backed by a financial mechanism of some form – market or policy induced </li></ul>
  23. 23. Policy context <ul><li>Setting the example: American (Renewable Energy Portfolio Standards/production incentives/tax credits) and the Chinese (capital subsidies/production incentives in certain regions) small-scale wind turbine markets are testament to the fact that an enabling policy environment will bolster viability </li></ul><ul><li>South African renewable energy policy framework offers no known facility which directly supports investors in microgeneration renewable energy technologies </li></ul><ul><li>No tariff subsidy system for renewable energy in SA – proposals for a feed-in tariff have been submitted </li></ul>
  24. 24. Mechanisms for growth and development of the SA small-scale wind turbine market: capital subsidization <ul><li>High initial capital investment: single most significant financial barrier </li></ul><ul><li>Majority of South Africans can’t afford this large initial investment </li></ul><ul><li>Capital subsidy grants can reduce this capital cost and significantly enhance the viability of the turbines </li></ul><ul><li>The Low Carbon Buildings Programme implemented in the UK </li></ul><ul><li>Renewable Energy Finance and Subsidies Office or the Energy Development Corporation may have the capacity to provide such a subsidy grant, but do they have the resources or commitment? </li></ul><ul><li>Low-cost financing </li></ul><ul><li>Partnerships making access to finances potentially easier </li></ul><ul><li>Criticism: capital subsidies will not necessarily result in the growth of the local manufacturing industry </li></ul><ul><li>Production incentives: export credits or tax breaks/credits </li></ul>
  25. 25. Mechanisms for growth and development of the SA small-scale wind turbine market: tariff subsidization <ul><li>Feed-in Tariff mechanism: </li></ul><ul><ul><li>driven the expansion of wind energy industry in Germany </li></ul></ul><ul><ul><li>how does this function? </li></ul></ul><ul><li>Not of advantage to small-scale turbines owners: function of turbines is predominantly to provide energy for their own consumption and not for export back into the grid </li></ul><ul><li>Second form of tariff subsidy: pays the IPP based on the sum of electricity that is generated from renewable energy regardless of whether this electricity is consumed by the producer or distributed back to the grid – applied in financial analysis in this paper </li></ul><ul><li>Instituted in the UK under the Renewables Obligation Certificate programme </li></ul><ul><li>More advantageous to small-scale wind turbine owners </li></ul>
  26. 26. Mechanisms for growth and development of the SA small-scale wind turbine market: tariff subsidization <ul><li>Financial analysis indicates that subsidies well in excess of current electricity charges will be required for turbines to be viable </li></ul><ul><li>Case of a 5kW turbine: a tariff subsidy of around 80c would be required; 200% inflation on the current tariff charge </li></ul><ul><li>Too demanding for Eskom or SA government: competing with other programmes </li></ul><ul><li>Local consumers have displayed great resistance to hikes in electricity tariffs and are unlikely to support cross subsidization of tariff subsidies </li></ul>
  27. 27. Mechanisms for growth and development of the SA small-scale wind turbine market: carbon credit markets <ul><li>Global carbon market is growing rigorously doubling in size in 2007 as climate change moves increasingly into the foreground of government and corporate agendas </li></ul><ul><li>Renewable energy project developers in the non-industrialized countries can access carbon credits through the CDM market or voluntary markets </li></ul><ul><li>CDM opportunities </li></ul><ul><ul><li>A number of emission reduction projects in South Africa are participating in the sale of CER credits </li></ul></ul><ul><ul><li>Small-scale projects typically cannot afford to partake in the CDM process as a result of the high transaction costs involved </li></ul></ul><ul><ul><li>Executive Board of the CDM has designed modalities through which these costs can be significantly reduced for small-scale projects </li></ul></ul><ul><ul><li>Option of a collective of small-scale projects bundling together to minimize transaction costs </li></ul></ul><ul><li>Opportunities in voluntary carbon markets </li></ul><ul><li>At current carbon prices the viability of small-scale wind turbines in SA is not viable </li></ul>
  28. 28. Conclusions <ul><li>The wide-scale application of small-scale wind turbines can potentially make a contribution in assisting government meet its RE target </li></ul><ul><li>Small-scale wind turbines offer SA consumers a number of benefits: </li></ul><ul><ul><li>an opportunity to protect themselves against the impacts of power-outages and load-shedding and rising fossil fuel and electricity tariff prices </li></ul></ul><ul><ul><li>an opportunity reduce their personal carbon footprint and assist South Africa in curbing its high level of emissions </li></ul></ul><ul><ul><li>an opportunity to improve the quality of their own power supply </li></ul></ul><ul><li>This paper has suggested that under certain conditions the benefits from the turbines would outweigh the costs to consumers and if they were to be supported by financial mechanisms they would be even more viable </li></ul>
  29. 29. Conclusions <ul><li>A tariff subsidy based on the total amount of electricity generated or an upfront capital subsidy grant would appear to be the most effective form of financial support and will offer the greatest assistance in overcoming the obstacles presented by the low tariff rates in South Africa and the high initial capital costs of the turbines </li></ul><ul><li>The financing of these support schemes will however present a number of challenges especially given the number of socioeconomic challenges in SA </li></ul>
  30. 30. Thank you.