June 21, 2017
By Patrick L. Schmidt and Nick Sangermano
With the confluence of positive factors described in Part 1 of this article — abundant sun and wind, significant support from various governments, multi-lateral banks, and NGOS, plus the overwhelming business case and substantial potential savings to be realized from adopting renewable energy in the Caribbean — why has the pace of adoption of renewables not been more rapid?
Indeed, there has been progress, but it has been slow and uneven, depending on the island. There are several reasons for this.
Legal and Regulatory Issues
First, some islands lack the necessary legal and regulatory framework to support a transition to renewable energy. For example, the regulatory scheme should allow for the entry of self-generating customers and Independent Power Producers (IPPs) with appropriate safeguards whenever this can provide generation at reduced costs. If the utility lacks the financing capacity to invest in renewable projects, the IPP model allows the utility to shift the risk from its balance sheet to the IPP.
Safeguards are needed, however, to protect the long-term viability of the utility and the grid when it comes to self-generation and IPPs. In some smaller islands, in particular, larger energy users, such as resorts, wish to generate their own energy. And some have succeeded in doing so. This is a boon to the owners of the resort but poses a threat to the island and its residents.
If enough large users leave the grid, the utility may have difficulty in covering the fixed costs of the grid. This would place an undue burden on less affluent customers unable to afford self-generation, who would be forced to pay even higher electricity rates in order to support the grid. Unfunded infrastructure can become a real danger in these cases.
Another problem in the regulatory area, in the sense that it relates to good government practices, is that islands sometimes give concessions or exclusive rights to a private company without a competitive bidding process. A properly prepared and administered Request for Proposal (RFP) process will provide transparency and assure that the best value is obtained.
Lack of Access to Capital
Second, it can be difficult to finance renewable energy projects in the region. Lack of access to capital is an obstacle cited by many governments. Local lenders in the Caribbean often have little experience with renewable energy and appear unwilling or unable to develop the skills needed. And a lack of scale is the main impediment to financing from outside the region. Many distributed generation projects on a Caribbean island are simply too small to attract the needed financing. And the transaction costs for small projects can be relatively high.
Bundling a larger number of small projects into one is a possible solution. This would diversify the risks and bring the transaction costs to a reasonable level. But aggregating such projects is problematic, and so far in the Caribbean this has not been achieved in a significant way.
Image: Wind farm, Aruba
One reason aggregation is difficult is because the islands have no electricity interconnections. The potential benefits for regional electricity interconnections via submarine cables are significant according to a 2011 study by the World Bank, Caribbean Regional Electricity Supply Options Toward Greater Security, Renewables and Resilience.
Some islands in the Eastern Caribbean, such as Nevis, have abundant geothermal resources but cannot take full advantage of this natural resource. There is so little local demand that the projects must remain small, even though a geothermal project could be scaled up to provide many times more energy than is needed by Nevis. By connecting to nearby islands of Martinique or Puerto Rico, however, the market for geothermal energy could be expanded. The scale of the projects would increase accordingly, thus improving the viability of the investment. Geothermal energy, of course, has the added advantage of being base load, so there is no intermittency issue as with solar or wind energy.
Regional interconnections also would strengthen investments into wind and solar energy projects by mitigating concerns over intermittency at a macro level. Islands with solar and wind energy face the problem that intermittency has the potential to disrupt their small grids and can require a large amount of reserves. Interconnections with other islands, however, could improve efficiency and reduce reserve requirements. And as the region is plagued by hurricanes and power disruptions, the interconnections could help avoid prolonged power outages on an island if its connected neighbor is unaffected.
The attractiveness of such interconnections, however, diminishes as energy storage technology becomes increasingly cost effective. If an island can store its wind or solar energy on a cost-effective basis, it will have largely mitigated the intermittency problem and thus reduced the need for a cable interconnection on that front.
In addition, most countries view the reliable supply of electricity as a national security issue and may be reluctant to rely on another country for its power. And there are legal issues to be resolved as two countries may own different components of the energy production; for example, one owning the cable and the other owning the source of production, such as the geothermal plant.
Given the distinct nature of the countries and their energy needs, no single development path will be suitable for all countries, and it is important to consider different options. Project financing is the approach of many developers, but it can be difficult in the Caribbean where the offtakers frequently are not creditworthy. The country itself also may have a high degree of economic risk. And in some places the general climate for doing business is challenging. The timelines for development can be long and hence expensive, posing yet another disincentive for developers.
Electric Utility Companies Need a New Business Model
Third, an often-overlooked obstacle is the resistance of electric utility companies to embrace renewable energy. Whatever the ownership model of the utility — whether government owned or a long-term concession to a private company — the utility has little motivation to reduce its market share of the electricity production business by welcoming renewable energy to the grid.
The current business model of an island utility is built around diesel-based electricity production where the cost of fuel is passed directly to the consumer. This business model must change if utilities are to have any meaningful incentive to promote renewable energy. Failure to recognize this fundamental challenge — and to resolve it — will continue to be a drag on efforts to promote renewable energy in the Caribbean.
Some utility companies view renewable energy as a threat to their business and as an unwanted intrusion on their management of the grid, so they resist it. And with an impending loss of market share, they worry about a commensurate loss of jobs over time as the country shifts to renewable energy.
A study by Harrie Vredenburg, David Ince and Xiaoyu Liu published in 2016 in the journal Energy Policy conducted a survey of 36 political jurisdictions in the Caribbean analyzing the factors affecting the development of renewable energy. The article, Drivers and inhibitors of renewable energy: A qualitative and quantitative study of the Caribbean, confirmed what some developers and governments have long asserted — some utilities are dragging their feet on implementing renewable projects. The study concluded that “where the incumbent electrical utility was most influential in policy making, there was a statistically significant connection to reduced renewable energy.”
"So if an incumbent electric utility is heavily involved with government, advising government how to develop renewable energy policy, we find there is less renewable energy," explains Vredenburg. He adds, "Where the utility is kept more at arm's length and is not as influential, and governments perhaps use external international expertise to advise them, or somehow come up with policies more independently, we find there is a greater amount of renewable energy."
If the government is the owner of the utility, then it may have leverage to encourage the utility to adopt an approach that looks to the long-term benefit for the island rather than simply the financial return to the utility. A privately owned utility, however, is largely immune to such entreaties and may resist pursuing any significant renewable projects. And on some islands, there is little effective government regulation or oversight of the utility company, public or private. Even if the utility is state-owned, the influence of government may be ad hoc and limited without more comprehensive oversight by a legislative or regulatory body.
As a business, albeit a monopoly shielded from the rigors of competition, the utility must pay back the significant capital investment it has made in equipment for a fossil fuel generation system. And depending on how recent the purchase, the pay back term may be long, thus adding to a utility’s reluctance to embrace renewables that would reduce its revenue streams. This is a factor that utilities and governments together must address, but it should not be an excuse by a utility to delay progress on the renewable front.
The utility company has responsibility for ensuring the stability of the grid. This is a legitimate concern, of course, as intermittent sources of energy from solar and wind pose challenges to the stability of the grid. Solutions are available, however, so the concern about grid stability in and of itself is no justification to impede the introduction of renewables.
Electric utilities need a new business model that will encourage them to support the transition to renewable energy rather than to resist it. They must be open to pursuing new revenue streams as their islands pursue renewable energy projects. For example, a utility should consider taking an ownership stake in the projects. A utility’s traditional interests and way of doing business should be realigned to match the long-term interests of government in reducing its country’s dependence on fossil fuels while providing efficient renewable energy to its citizens.
Natural Gas May Impede Progress
Yet another factor that may slow the transition to renewables in the region is natural gas. While the transition to renewables is underway, some governments and investors are promoting natural gas as a “bridge” fuel, arguing it is substantially cleaner than other fossil fuels.
The U.S. is pursuing the export of its abundant natural gas to the region, having approved licenses for the export of liquefied natural gas. And the Inter-American Development Bank (IDB) is making financing available for LNG infrastructure in the region.
NGOs, such as Rocky Mountain Institute — Carbon War Room, and other proponents of renewable energy challenge the U.S. and IDB efforts, arguing that natural gas is a fossil fuel which neither promotes energy security nor protects the islands from a volatile energy supply. And supplying it is a disincentive that will only impede the development of renewables in the Caribbean.
They fear that natural gas will lock governments and utilities into highly capital intensive infrastructure projects and long-term supply agreements. A large investment in infrastructure is needed for the islands to transport and to utilize natural gas, making it difficult for them later to abandon these projects and to migrate to use of renewables.
Thus, critics of natural gas see it not as a bridge fuel, but rather a bridge to nowhere. For some Caribbean governments, however, no matter how committed they may be to the long term renewable vision, it is difficult for them to ignore the availability of cheap — and relatively clean — natural gas in the short to medium term.
The Caribbean has enormous potential for transitioning to renewable energy. Progress is being be made, but to unleash the full potential of the region a number of challenges must be overcome: the lack of adequate laws and regulations, the small scale of projects that makes access to financing difficult, the threat to grid stability from intermittent energy sources, the resistance of utility companies to a large-scale introduction of renewables, and the potential role of natural gas in delaying progress.
Patrick L. Schmidt (left) is Counsel to Hills Stern & Morley LLP, a boutique law firm representing clients in transactions in the Caribbean, Latin America, and other emerging markets.
Nick Sangermano is a Managing Director at CohnReznick Capital, a comprehensive financial advisory firm for the renewable energy and sustainability industries