Reflecting the azure skies of the Caribbean, solar panels on private houses, hotels and businesses are an increasingly common sight across all the islands. Many Caribbean customers are seeking a degree of energy independence, which is not surprising given that many pay five or six times as much for their grid-provided electricity than their neighbours in mainland USA.
While the Caribbean people care deeply about the preservation of their environment, particularly given its importance to tourism (their biggest export), it is not the danger of global warming that fundamentally drives the development of renewable energy in the region; it is affordability. The cost of energy is a dominant factor slowing economic development in the Caribbean, for example by driving up the cost of tourist hotels, resorts and infrastructure. A reliance on imported fossil fuels for electricity generation further exposes the region to energy supply shocks.
While the deployment of renewable sources and further self-generation would appear to offer a long-term solution, the issue is complicated, in particular with respect to the impact on the existing utility business model. However, as renewable penetration in the Caribbean starts to reach a critical threshold, it is just possible — with the right tariff regime, regulation framework and incentives — for the Caribbean to develop a sustainable energy framework which can balance the benefits to customers, utilities, new players and the economy as a whole.
We should acknowledge that each Caribbean country is different in terms of regulation, ownership of utilities, infrastructure and other factors. But there are a number of common themes. First of all, the Caribbean is heavily dependent on the import of fossil fuels (particularly diesel), and collectively the countries have a long-term concessional agreement with Venezuela for the supply of oil. Second, the Caribbean is endowed with significant indigenous renewable resources, mainly solar and wind but also hydro and geothermal for some countries. Third, electricity provision in the islands is typically the domain of vertically integrated utilities responsible for generation, distribution and supply. They invariably operate diesel-fuelled plant which is relatively easy to install and flex with demand, but is expensive to run and in many cases has poor efficiency. The pass-through of the utilities’ fixed costs onto customers is typically managed on a ‘cost plus’ basis.
Given the small size of many Caribbean island systems, this regime starts to break down (and quickly), once there are significant volumes of self-generating customers and once Independent Power Producers (IPPs) start to participate in the market. For example, as self-generation grows (e.g. rooftop solar), it may become increasingly difficult for utilities to cover the fixed costs of the centralised grid-based system, and in some cases the onus of payment can start to disproportionately fall upon poorer customers who cannot afford the upfront capital outlay for renewable self-generation.
While it could be argued that utilities have existing strong incentives to avoid fuel costs through renewables deployment, there is a danger that they find themselves in a vulnerable position as their existing revenue streams erode before new ones have developed. In turn, this situation could inadvertently raise barriers to further renewables deployment in the region.
In September 2014 the Caribbean Electric Utility Service Corporation (CARILEC) held its Fifth Regulatory Forum in the British Virgin Islands supported by the UK’s Foreign and Commonwealth Office (FCO) and the World Bank. The common focus for the Forum, and indeed many other similarly focused conference discussions in the region, was on the need to deliver reliability, affordability and sustainability of supply in systems with an increasing penetration of renewable energy.
On behalf of the FCO, Baringa Partners has produced a Thinkpiece which discusses the challenges raised at the Forum and offers some principles that could potentially guide regulatory change to produce ‘win-win’ results.
As we see it, the regulatory arrangements will need to evolve to reflect the changing market dynamics and to ensure that consumers pay no more than necessary for sustainable and secure supplies. Independent regulation will be critical to unlocking new private investment from IPPs while ensuring that utilities can pay their fixed costs, develop new services and remain part of the solution.
The design of tariffs that provide the right balance between incentivising self-generation and ‘energy independence’ and enabling the utilities to recover their fixed costs, is critically important. At the same time the regulatory framework needs to ensure that customers are only paying for the efficient costs of investing in and operating the system and therefore may need to evolve from the existing ‘cost plus’ regime of collecting fixed costs.
The entry into the market of utility-scale renewable IPPs represents another challenge to utilities. Utilities need to balance a fair price for IPP generation in the Power Purchasing Agreement (PPA), with the need to optimise the efficiency of the system and ensure efficient cost recovery for shared assets and services. IPP entry may well be to their advantage, for example to the extent that it allows the cost and risk of new investment to be passed onto IPPs, which can in turn attract new skills and capital into the sector. The regulatory framework will play an important role here also, for example as we have observed recently in New York with the announcement of the ‘Renewable Energy Vision’ (REV) reforms, where incumbent utilities and IPPs will be able to mutually benefit from partnership and facilitation.
Looking to the long-term, utilities can redefine their business model by developing new business opportunities through the provision of network capacity, ancillary and balancing services, and metering and other supply-related services. They particularly stand to benefit from the creation of innovative utility-scale storage solutions that enable greater renewables penetration. Essentially, we see Caribbean utilities as having a critical role in the management of a more complex renewables-based system with multiple participants.
To facilitate these significant shifts in the existing utility business model, we see a key role for ‘incentive-based regulation’, taking onboard lessons from the UK ‘RIIO’ framework as well as the New York REV reforms. These are the next generation regulatory approaches: which not only holds utilities to account but also encourages and rewards those that provide efficient and reliable services at the lowest long-run costs to consumers. Using commercial incentives, these approaches can nudge utilities away from predominantly ‘asset provision’ towards a greater focus on ‘service provision’. This would enable a better alignment of commercial incentives with the overall government policy objectives of encouraging efficient renewables while reducing reliance on fossil fuels.
Maintaining the status quo with the current business model and regulatory framework does not appear to be workable in the long-term. In a worst case scenario, it could lead to a breakdown of the system, with failure of utilities due to unfunded infrastructure. More realistically, it may lead to some reluctance on the part of utilities to proactively enable renewable deployment, which would represent a huge missed opportunity. On the other hand, the size of the Caribbean energy sector is sufficiently small to enable relatively rapid adaptation. The sector could in fact ‘skip a few steps’ in terms of development, placing Caribbean utilities at the frontier of the new global utility model of the future. The Caribbean could well become an example for other small island nations with high electricity costs to follow, including many in South East Asia and the Pacific.
Credit: Peter Sherry, Baringa Partners