RENEWABLE 41598 ENERGY NICARAGUA Unlocking Potential, Reducing Risk Renewable Energy Policies For Nicaragua Wolfgang Mostert Energy Sector Management Assistance Program Copyright © 2007 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, NW Washington, DC 20433, USA All rights reserved Printed in India First printing August 2007 ESMAP Reports are published to communicate the results of ESMAP's work to the development community with the least possible delay. The typescript of the paper therefore has not been prepared in accordance with the procedures appropriate to formal documents. Some sources cited in this paper may be informal documents that are not readily available. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank, or its affiliated organizations,ortomembersofitsBoardofExecutiveDirectors or the countries they represent. 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RENEWABLE ENERGY Special Report 003/07 August 2007 Masami Kojima Unlocking Potential, Reducing Risk Renewable Energy Policies For Nicaragua Wolfgang Mostert Energy Sector Management Assistance Program Contents Preface vii Acknowledgments ix Acronyms and Abbreviations xi Key Terms xiii Units of Measure xiii Major Laws and Decrees xiv Executive Summary xv 1. Introduction 1 Plenty of Renewable Energy; Scarcity of Investment 1 Failed Power Sector Reform 3 Study Focus 4 Organization of this Report 4 2. Power Sector Overview 7 RE Share in Electricity Generation 7 Installed Capacity and Potential 7 Price Competitiveness 7 Power Sector Reform 8 Separation of Generation Assets 9 Division of Distribution 9 Transfer of Transmission 10 Bulk Power Market 10 Retail Tariffs and Cross-subsidies 12 Public Governance 13 Organization of Rural Electrification 14 CNE Planning and Implementation 14 Financing Policy 15 Failed Reform and Political Risk 16 Risk Premiums 17 Immature Capital Market 18 Regional Power Market 18 iii Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua 3. Resource Potential and Exploitation Status 19 Resource Potential 19 Geothermal Energy 19 Hydropower 21 Wind Energy 23 RE Project Experience 24 Geothermal Projects 24 Hydropower Projects 26 Wind Farm Projects 27 4. RE Policy and Regulatory Framework, 1998-2005 29 Political Context and Policy Targets 29 Resource Management Laws and Regulations 30 General Laws and Regulations 30 Geothermal Exploitation 30 Water Resources Exploitation 31 Power Market Rules 32 Bidding for Generation 32 Intermittent Supply Rules 33 Grid Connection Rules and Prices 36 Is a Mandated Market Needed? 36 Standardized Administrative Procedures 37 What Is Nicaragua's Concession Policy? 37 Prefeasibility Study Licenses 38 Contracts and Bidding Procedures 38 One-stop Shop for Developers 38 Local Approval Regulations 39 Incentives Regime 39 Government's Risk-sharing Role 39 Investment Incentives 39 Subsidized Infrastructure 40 Project Finance Conditions on National Capital Market 40 Support to Local Supply Industries and R&D 41 What Is Missing in Nicaragua's RE Policy? 41 Beyond CNE's Policy Drive 41 Beyond 2005: Policy Wake-up Call 42 5. Breaking the Cycle: Renewable Energy (RE) Policies and Strategies 45 Increasing Investor Confidence 46 Reduce Off-take Risk of Sales to Union Fenosa 46 Introduce Power Brokers in the Bulk Market 47 Use Appropriate Mandated Market Instruments 48 Promote Regional Power Market 49 Reducing Investor Risk 49 Adopt Regulations for Resource Exploitation 49 Streamline Approval and Planning Procedures 50 Invest in Resource and Project Cost Information 51 iv Contents Promote Public Risk-sharing in Geothermal Exploitation 51 Install Appropriate Incentive Regime 53 Strengthen National R&D and Supplier Base 53 Improving Access to Project Finance 53 Tap National Debt and Equity Capital: Bond Issues 53 Introduce Partial Risk Guarantees and ContingentFinance 55 Analyze Feasibility of Mini-hydro Leasing Schemes 56 Use Subsovereign Guarantees for Community Investment 57 Use Environmental Finance 57 Use Bank Credits 58 Introduce Risk Guarantees for Foreign Investments 58 Integrating RE into Rural Electrification 59 Analyze Financing Options 59 Support DER as FODIEN Secretariat 59 Support FODIEN's Subsidy Functions 59 Promote Stand-alone Systems in Absence of Grid 60 Final Observations 60 6. Concluding Remarks 61 References 63 Annexes Annex1: RE Legal and Regulatory Framework 65 Annex2: Compatibility of Legal Framework with 69 Proposed Policy Annex3: International Experience with RE Frameworks 79 v Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua Tables 1.1: Nicaragua's Business Environment for Private RE Investment 4 2.1: RE Share in National Power Supply, 2005 8 2.2: Risk Premium's Effects on Cost of Capital and Generation 17 2.3: Effects of Loan Maturity on Generation Cost 17 3.1: Geothermal Resource Projections for Nicaragua 19 3.2: Estimated Potential of Identified Hydropower Sites 21 3.3: Estimated Costs of Wind Farm Power Production 24 A2.1: INE Opinion on the CNE Bill Promoting RE Generation 76 A3.1: Percentage of RE in Central American Electricity Production, 1980-2002 83 A3.2: Electricity Industry Variables for Central America, 2002 84 Figures 1.1: Spread of Nicaragua's Renewable Resources 3 2.1: Organization of the Bulk Power Market 11 2.2: Residential Tariff Structure, 2004 (US$ per kWh of monthly consumption) 12 3.1: Distribution of Geothermal Energy Potential 20 3.2: Distribution of Nicaragua's Hydropower Potential 22 4.1: CNE Options for Intermittent Power Access 34 5.1: Proposed Strategy for Promoting RE Investments 45 5.2: One-stop Clearinghouse Organization 50 5.3: Revenue Bonds and the Project Finance Cycle 54 5.4: Organization of Mini-hydro Lease-Buy-back Scheme 56 A3.1: Organization of IPP Merchant Plant 82 Boxes 1.1: Nicaragua's Legacy: Progress Amid Crisis 2 2.1: Legislative Framework for Power Industry 9 2.2: Institutional Roles and Responsibilities 13 2.3: Why Did Power Sector Reform Fail? 16 4.1: Postreform: A Regional Perspective 42 vi Preface This strategy work was launched in response to a dilemma that was recognized early on by the Comisión Nacional de Energía (CNE) of Nicaragua, and encapsulated in the introduction to this synthesis report. Why was it that Nicaragua, endowed with perhaps the richest collection of renewable energy resources in Central America, ranked last in the subregion in utilization of this resource? Given Nicaragua's limited financial resources, the study soon focused the challenge of private sector resource mobilization. While country risk and macroeconomic instability loomed as significant factors limiting private sector willingness to invest in renewable resource development, it became apparent that a large fraction of the investment barriers were inherent in the policy and incentive framework of the energy sector itself. Some of these barriers were unwittingly introduced in the course of implementing a wide-ranging electricity sector reform and restructuring in the year 2000. The study therefore took a case study approach in order to analyze investment impediments from a private sector perspective. Case studies were carried out for small to medium hydropower, geothermal and wind energy as the three major renewable potentials in the country. The case studies were informed through close contact with both the local developer and international investor communities. The case study outputs provided clarity and confirmation of specific sectoral policy and information barriers, and provided a solid basis for the formulation of the measures recommended in the synthesis report. While this work focuses on conditions in Nicaragua, many of its observations and recommendations can be generalized to the global problem of ensuring that environmental considerations (represented in this case by avenues for renewable energy) are adequately ingrained into the design of power sector reforms. In addition, the lessons learned are equally applicable to the challenge of assuring energy security through supply diversity in an era of high and volatile fossil energy prices. vii Acknowledgments This report, written by Mr. Wolfgang Mostert, builds on the findings of several studies supported by Nicaragua's National Energy Commission (CNE) and the World Bank's Energy Sector Management Assistance Program (ESMAP). Global Power Solutions, led by Mr. Robert E. Tucker, provided information on geothermal energy (GPS 2006). Mr. Oscar Jiménez and Mr. Alfredo Povedano analyzed the wind farm situation (Jiménez and Povedano, 2003), while Mr. Thomas M. Scheutzlich covered the perspective on hydropower generation (Scheutzlich, 2004). These complementary reports have been compiled on a CD-ROM attached at the end of this report. CNE's management and staff were extremely helpful in providing information and feedback on presentations of findings and recommendations. The CNE President, Mr. Raúl Solórzano, offered ongoing support at the political level. Ms.Gioconda Guevara and Mr. Ricardo Mendoza were the driving force behind day-to-day work and discussions. Their hospitality and intellectual feedback were a strong stimulus for the work undertaken. At the World Bank, appreciation is extended to Mr. Charles Feinstein, Sector Manager, Energy Sustainable Development Department, Europe and Central Asia Region (Formerly, Sector Leader for Finance, Private Sector and Infrastructure, Latin American and the Caribbean Country Management Unit) who was responsible for the collaboration between ESMAP and CNE, identifying key issues for analysis, coordinating the work of contracted consultants, and organizing workshops and policy seminars with CNE. Thanks also go to Mr. Douglas F. Barnes, Senior Energy Specialist, Energy, Transport and Water Department who provided constructive criticism of the first draft of the report, and to Ms. Clemencia Torres De Mastle, Senior Regulatory Economist in the Latin America and the Caribbean Region, for her valuable advice and support throughout the study. Ms. Norma Adams, editor, took on the task of transforming a complex manuscript into a readable document. Special thanks to Mr. Daniel Farchy, Ms. Marjorie K. Araya and Ms. Ananda Swaroop for coordinating the editing, production and dissemination of the final report. ix Acronyms and Abbreviations ANAM National Environment Authority ARESEP Regulatory Authority for Public Services BANOBRAS National Bank for Infrastructure and Services BCIE Central American Bank for Economic Integration BOO build, own, operate BOT build-own-transfer BOOT build, own, operate, transfer CAPM capital asset pricing model CDM clean development mechanism CER certified emission reductions CIDA Canadian International Development Agency CNE National Electricity Commission CNFL Power and Light Company COPE Energy Policy Commission CRIE Regional Electric Power Interconnection Commission DECASA Central America Energy Distributor, SA DGE General Energy Administration DNE National Electricity Directorate DTIUK Department of Trade and Industry EEGSA Guatemala Electric Power Company EEMS municipalcompanies EGAT Electricity Generating Authority of Thailand EIAs environmental impact assessments ENEE National Electric Power Company ESB Electricity Supply Board ETESA Electric Power Transmission Company, SA FOGES guarantee and stabilization fund GAUREE autonomous generation and rational use of energy power in Honduras GDP gross domestic product GEF Global Environment Facility GECSA Central Power Company GGG Guatemala Generating Group HFO heavyfueloil IAEA International Atomic Energy Agency ICE Costa Rican Electricity Institute xi Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua IDB Inter-American Development Bank IEP indicative expansion plan GPS Global Power Solution IFC International Finance Corporation (of the World Bank Group) INAA Nicaraguan Sewerage and Aqueduct Institute IPPs independent power producers INDE National Electrification Institute MEM Ministry of Energy and Mines MIGA Multilateral Investment Guarantee Agency MINAE Ministry of Environment and Energy NGO nongovernmentalorganization NPV net present value NRECA National Rural Electric Cooperative Association OECD Organisation for Economic Co-operation and Development OMCA Central American Market Operator PCA Central American Hydropower Plant PERZA Rural Electrification Program for Atlantic Region PGEFR Renewable Energy Generation Project PMD municipal development plan PND nationaldevelopmentplan PPA power purchase agreement PPP purchasing power parity PSB Santa Barbara Plant PV photovoltaic R&D research and development RE renewable energy RECs Rural Electric Cooperatives REF rural electrification fund RPS renewable portfolio standard SBS small business service SERNA Natural Resources and Environment Secretariat SFLG small firms loan guarantee SHPs small hydropower plants SHS solar home system SIEN Nicaraguan Energy Information System SIFER renewable energy system development SIGET superintendent of electricity and telecommunications SNIDE national energy information and documentation system SPP small power producer SPV solarphotovoltaic TELCOR Nicaraguan Institute for Telecommunications and Postal Services VAT value added tax xii Key Terms English Spanish bulk power market mercadomayorista bulk power price precio mayorista large consumers grandesconsumidores monomial price (average price from the spot and preciomonómico contract markets equal to the kilowatt-hour price of the bulk power market) nationalheritage patrimonionacional one-stopshop ventanillaúnica power broker comercializador PPA contracts market mercado de contratos PPA regulating reserve reserva de regulación run-of-the-river filodeagua short-term capacity market mercado de corto plazo de capacidad spinning reserve reserva rodante spotmarket mercadoocasión spotprice preciospot Units of Measure GWh giga watt (s) per hour kV kilovolt kW kilo watt (s) kWh kilo watt (s) per hour MMBTU million British thermal unit MW mega watt (s) MWh mega watt (s) per hour km2 square kilometer Toe ton equivalent of oil xiii Major Laws and Decrees Number-Year English Spanish 217-1996 Environment and Natural Ley General del Medio Ambiente y los Resources Law Recursos Naturales 6-1997 1997 Regulatory and Institutional Marco Regulador e Institucional para el Servicio de la Framework for Public Electricity Electricidad Pública 1997 Service Law 42-1998 Electricity Industry Law Reglamento a la Ley de la Industria Eléctrica Regulation (Decree) 271-1998 Reform of the Founding Law of the Ley de Reformas a la Ley Orgánica del Instituto Nicaragua Energy Institute Nicaragüense de Energía 272-1998 Electricity Industry Law Ley de la Industria Eléctrica 14-1999 Nicaragua Protected Areas Reglamento de Areas Protegidas de Nicaragua Regulation (Decree) 128-1999 Electricity Industry Law Reglamento a la Ley de la Industria Eléctrica Regulation (Decree) 443-2002 Geothermal Resource Exploration Ley de Exploración y Explotación de and Development Law Recursos Geotérmicos 462-2003 Forestry Law Ley Forestal 467-2003 Hydropower Promotion Law Ley de Promoción al Sub-sector Hidroeléctrico 2003 Water Rights Bill Anteproyecto Ley del Uso de Agua 52-2003 Incentives for the Development of Ley de Incentivos para el Desarrollo de Proyectos de Renewable Energy Projects Law Energía Renovable 12-2004 Wind Energy and Run-of-the-river Decreto de Apoyo al Desarrollo de los Recursos Hydropower Policy Support (Decree) Eólicos e Hidroeléctricos de Filo de Agua 13-2004 National Energy Policy (Decree) De Establecimiento de la Política Energética Nacional 33-2005 Reform of Electricity Industry Law Reforma al Decreto 42-1998 Reglamento de Regulation (Decree 42-98) la Industria Eléctrica 531-2005 Amendment to the Promotion Law Enmienda Ley de Reforma a la Ley 467 de for Hydropower Promoción al Sub-sector Hidroeléctrico 532-2005 Renewable Energy Promotion Law Ley para la Promoción de Generación Eléctrica con Fuentes Renovables 554-2005 Energy Service Stability Act Ley de Estabilidad del Servicio de Energía Eléctrica en el País 511-2006 Public Services Superintendency Law Ley de la Superintendencia de Servicios Públicos xiv Executive Summary Nicaragua, Central America's largest country, is decades of oppression and civil war ­ and low endowed with abundant, high-quality renewable national income. Some 77 percent of rural energy (RE) resources. In 2004, the economically residents and 64 percent of urban ones viable RE potential of 3,000 mega watt (s) (MW) ­ (70 percent of the overall population) live in consisting of hydropower (1,700 MW), conditions of poverty. Since the early 90s, geothermal energy (1,000 MW), wind energy investment in productive infrastructure (200 MW) and biomass (100 MW) ­ was five has stagnated. By the end of 2003, the times higher than the national power capacity. electrification rate had reached only 55 percent Thanks to these rich resources, new geothermal nationally and only 30 percent in the rural areas. and hydropower plants and wind farms can supply power at a lower risk-adjusted cost per Lack of investor confidence in RE has been fueled kilo watt (s) per hour (kWh) than conventional by the failed power sector reform of 1998-99. thermal plants. They can also provide price Design criteria, which should have included stability, save foreign exchange, generate increasing Nicaragua's rate of rural electrification employment, increase national and developing its rich RE potential, took neither value-added and reduce the country's exposure into account. Institutional and financial to the risk of potentially increasing fuel prices. arrangements to accelerate rural electrification The large capital requirements for RE investment were too weakly defined and had to be adjusted offer an excellent opportunity to accelerate in later years, while the power market scheme development of a national capital market. prevented new RE generators from securing long- term supply contracts on a competitive basis. Yet, despite RE's rich potential and price Unfortunate sequencing of implementation also competitiveness, the share of RE supply in contributed to the failure. Privatization of the Nicaragua's national power production has State-owned hydropower company failed because declined 30 percentage points over the past an important new water rights law had not been 25 years (from more than 60 percent in 1980 to adopted. In addition, the new private distribution 35 percent in 2005), while that of diesel-fired company had difficulty fighting electricity theft power has continued to increase. The reasons because the legal framework was insufficiently why investments with clear economic and financial equipped to punish it. advantages have not been preferred involve a variety of factors in the country's business and The 1998-99 reform process divided the public regulatory environment. At the macroeconomic governance functions for the power sector level, major obstacles have included deep political between the National Energy Commission (CNE) divisions and confrontations ­ the legacy of and the National Energy Institute (INE). Since xv Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua reform, these policy and regulatory institutions Breaking the barriers to RE investment in have disagreed on important issues, thereby Nicaragua means moving beyond the status quo. impeding a coherent approach to rural To correct fundamental flaws, a set of electrification. Their battle over institutional comprehensive and coherent policy initiatives and authority in assigning and regulating water rights, strategies is called for. Unlocking the country's RE for example, has delayed adoption of the potential and, at the same time, reducing the country's new Water Rights Law. Such turf battles political and regulatory risk for investors, requires have increased investment risk and hurt two major policy initiatives: promoters' ability to plan and implement projects. · Elimination of the fundamental, legal and Nicaragua's postreform situation is not unlike that regulatory obstacles to investment in medium- of four of its Central American neighbors, who and large-scale RE generation. For geothermal also implemented power sector reforms in the late energy, this implies making adjustments to the 90s. El Salvador, Guatemala, Honduras and National Park Law; for hydropower, it means Panama, like Nicaragua, have witnessed the adopting the new Water Rights Law; and reality that liberalization favors power sector · Parliament's adoption of the new RE law. This investments with short payback periods, while such law sets minimum RE penetration targets in the capital-intensive investments as hydropower and national power market by 2010, 2015 and geothermal energy are stymied. In their 2020; it also provides a coherent set of policy, generation portfolios, all five countries have regulatory and incentive measures to eliminate clearly expressed their preference for RE for market distorting barriesrs. reasons related to the environment, foreign exchange and long-term price stability. All have The proposed strategy for promoting RE lamented that private sector RE investments investment in Nicaragua offers a comprehensive, have been delayed, yet, none has imposed a cost-effective approach to reducing demand- and moratorium on conventional thermal power supply-side barriers to investment, improving investment. All have had difficulty obtaining access to project finance and integrating RE parliamentary approval of their respective water promotion into the rural electrification policy. laws. These countries, along with Costa Rica, share an interest in designing rules for a The strategy's four modules highlight two key Central American power market that facilitate terms: comprehensiveness and risk management. investment in RE-based generation in their RE experience in Nicaragua and around the world respective countries. has underscored the lesson that comprehensive ­ Lessons from international experience suggest that not partial ­ approaches are effective in unlocking two factors are critical for RE policy success: 1) a a country's RE potential. Above all, the strategy comprehensive regulatory framework; and 2) aims to eliminate investor risk of political and government's adoption of published, quantified regulatory uncertainty. In Nicaragua, reducing risk targets for RE penetration into the power market and uncertainty provides investors a stronger by specified years. By the end of 2005, signal and is more cost-effective than investment Nicaragua's RE policy and regulatory framework incentives. Indeed, investment incentives are a contained many of the relevant building blocks for minor complementary and, in the end, success but lacked critical fundamentals: dispensable part of the RE strategy: under the quantified targets for RE penetration, adequate right regulatory conditions, RE investments in natural resource laws and appropriate power Nicaragua are fully competitive with conventional rules for tendering new generation. thermal power projects. xvi Executive Summary On the demand-side, the strategy aims to Competition for new projects can be increased increase investor confidence by proposing and the cost of production and bid prices per kWh recommendations that reduce off-take risk for RE reduced if private investors ­ both national and generation. Four specific interventions are foreign ­ gain access to national and regional offered: 1) reducing off-take risk of sales to sources of project finance. Because RE projects distributor Union Fenosa (assisting Union Fenosa differ substantially in size, technology and cost per in reducing distribution losses and using risk- and MW, financing options must be flexible. CNE's benefit-adjusted prices in tenders for new strategy comprises initiatives in seven areas: generation); 2) introducing power brokers in the 1) tapping national debt and equity capital (bond bulk market; 3) using appropriate mandated issues); 2) introducing partial-risk guarantees and market instruments (a niché market for contingent finance; 3) analyzing the feasibility of intermittent power supply from wind energy and mini-hydro leasing schemes; 4) using sub- run-of-the-river (ROR) hydropower and a 10-year sovereign guarantees for community investment; moratorium on the construction of conventional 5) using environmental finance; 6) using bank thermal power plants to develop the mass RE credits; and 7) introducing risk guarantees for market; and 4) promoting the Central American foreign investments. Electric Interconnection System (SIEPAC), Central America's regional power market. Finally, the strategy seeks to integrate RE into rural electrification. Wherever they can reduce the cost On the supply-side, the strategy works to reduce of power supply in rural electrification projects ­ investor risk by offering measures that can both on- and off-grid ­ micro and mini increase the necessary competition in supply and hydropower plants; small-scale, biomass-fired reduce production cost per kWh of output from power plants; and solar photovoltaic (SPV) systems future RE generation. Six major areas of supply- will be promoted effectively. Specific interventions side interventions are recommended: 1) adopting are to: 1) analyze financing options; 2) support regulations for resource exploitation; the Rural Electrification Administration (DER) to 2) streamlining approval and planning serve exclusively as secretariat of the National procedures; 3) investing in resource and project Electricity Development Fund (FODIEN) (thereby cost information; 4) promoting public risk-sharing eliminating CNE's conflicting roles as both in geothermal exploitation; 5) installing an policymaker and project implementer); appropriate incentive regime; and 3) support FODIEN's subsidy functions; and 6) strengthening the national research and 4) promote stand-alone power systems in the development (R&D) supplier base. absence of grid-based electrification. xvii 1. Introduction Situated along the Central American isthmus economic growth has returned. During the between Honduras and Costa Rica, Nicaragua is 1996-2002 period, economic growth averaged the region's largest country, with a territory of a modest 2.6 percent per year. In 2002, per 129,500 square kilometers (km2). Nicaragua is capita income was US$7102 (US$2,500 at also Central America's most sparsely populated purchasing power parity [PPP]);3 while income country per km2; 43 percent of its 5.5 million distribution was one of the most unequal in the people reside in rural areas. The country boasts of world (Box 1.1). the world's10th largest freshwater body, Lake Nicaragua; nearly 20 percent of the Nicaraguan Today, Nicaragua remains one of the Western territory is protected as national parks or Hemisphere's poorest countries. Some biological reserves. 77 percent of rural residents and 64 percent of urban ones ­ 70 percent of the overall population Historically, Nicaragua's economy has been based ­ live in conditions of poverty.4 Widespread poverty on the export of cash crops, including banana, explains the country's low per capita consumption of beef, coffee, rum and tobacco. Agriculture still electricity (281kilo watt (s) per hour [kWh]). Indeed, employs a significant percentage of the labor force at the end of 2003, the national electrification rate ­ 31 percent ­ generating 18 percent of the had reached only 55 percent. Poor economic gross domestic product (GDP). The services sector conditions and repercussions of civil war have comprises 55 percent of the labor force and 52 resulted in the exodus of an estimated 2 million percent of GDP, while the industry accounts for 17 people from Nicaragua. and 27 percent, respectively.1 Plenty of Renewable Energy; Scarcity In the early 80s, civil war damaged or destroyed of Investment much of the country's infrastructure; for a time, inflation ran at several thousand percent. Over Nicaragua's RE potential is both large and the past two decades, however, many State- varied. In 2004, the economically viable RE owned industries have been privatized, inflation potential of 3,000 mega watt (s) (MW) ­ has been brought to manageable levels and composed of hydropower (hidroeléctrico) 1 CIA World Factbook. 2 World Bank data (www.worldbank.org). 3 www.lexmundi.com. 4 In 2002, the national poverty rate (percentage of people living on incomes of US$2 or less per day) was 47 percent; nearly 40 percent of people lived in conditions of absolute poverty (US$1 or less per day). 1 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua Box1.1:Nicaragua'sLegacy:ProgressAmidCrisis Nicaragua's turbulent transformation from authoritarian rule to constitutional democracy has been marked by political crises and natural disasters. The capital city of Managua was never completely rebuilt after a 1972 earthquake that left 500,000 homeless. The repressive Somoza regime, which ruled the country for more than 40 years, was finally overthrown by the Sandinistas in the late 70s. Despite promises of prosperity, Sandinista revolutionary rule of the 80s drove the country to economic ruin. The 1990 election of President Violeta Chamorro ­ marking the nation's first peaceful transfer of power from one party to another ­ was a turning point that, over the next six years, laid the foundation for democratic inclusiveness and economic growth. The Chamorro administration consolidated democratic institutions, stabilized the economy, privatized State-owned enterprises and reduced human rights violations. Although Chamorro's successor, Arnoldo Alemán, continued economic liberalization, his administration lacked transparency and accountability. In 2003, he himself was sentenced to 20 years in prison on charges of corruption and fraud, even as the country struggled to recover from the 1998 shocks of Hurricane Mitch and a worldwide crash in the price of coffee, the country's major export. Amid these crises, Nicaragua has managed to rein in hyperinflation, cut military spending and open up its economy. At the same time, 77 percent of the rural population ­ 45 percent of the total population ­ and 64 percent of urban residents live in poverty. Since the early 90s, investment in productive infrastructure has stagnated. By the end of 2003, the national electrification rate was 55 percent (70 percent urban and only 30 percent rural). The current administration of Enrique Bolaños offers Nicaraguans hope for stability and continuity. Clearly, achieving sustainable economic growth requires policies and actions that increase access to productive and basic infrastructure services and strengthen the country's major institutions. Sources: The World Bank (2004), D. Close and K. Deonandan (2004), R. Miranda and W. Ratliff (1993) and D. Close (1999). (1,700 MW), geothermal (geotérmico) (1,000 MWh; several potential ROR hydropower plants MW), wind (eólico) (200 MW), and biomass are believed to have financial production costs (biomasa) (100 MW) ­ was five times higher below US$60 per MWh, while those of wind than the national power capacity. These RE farms (at the better sites) are about US$54-66 resources, particularly hydropower, are of high per MWh. quality. Moreover, they are spread throughout Investments in Nicaragua's RE-based power the country, providing an excellent balance for generation, versus conventional power plants the power system (Figure 1.1). (diesel, coal, natural gas), offer additional advantages; they: The cost of production per kWh is competitive. Between November 2000 and June 2003 (before · Provide more employment and higher national the 2004-06 increases in international oil, gas value-added (GDP) per kWh; and coal prices), the average price for bulk power · Save foreign exchange (in 2002, Nicaragua was US$60-71 per mega watt (s) per hour (MWh). spent US$244 million to import 1.2 million ton To be commercially viable, geothermal power equivalent of oil (Toe) of petroleum products, of projects in Nicaragua require US$65-70 per which 34 percent was used in power 2 Introduction Figure1.1:SpreadofNicaragua'sRenewableResources Energy Supply Studied Honduras Raan Jinotega NuevaSegovia Madriz Esteli Matagalpa Chinandega Leon Boaco Raas Oceano Masaya Chontales Managua Pacifico Granada Carazo Rio San Juan Hydroelectric Rivas Biomass Geothermal CostaRica Wind Source: National Energy Commission. production); RE policy and strategy are concerned with · Increase price stability of the power market; finding appropriate responses to obstacles at · Reduce the country's exposure to the risk of the meso and micro levels. Macro-level potentially increasing fuel prices; and factors ­ the country's overall political and · Because of their capital intensity, offer an economic context ­ act as constraints. For opportunity to accelerate development of a example, the price competitiveness of national capital market. capital-intensive generation projects is affected by the country's small size and low Despite these advantages, RE's share in the per capita income, which lead to an national power generation has declined more than underdeveloped capital market; while 30 percentage points over the past 25 years (from political insecurity adds a risk premium to more than 60 percent in 1980 to 35 percent in foreign and local finance. 2005),5 while that of diesel-fired power has Failed Power Sector Reform continued to increase. The reasons why investments with clear economic and financial Lack of investor confidence has been advantages are not preferred involve, as fueled by the failed power sector reform of always, the business/regulatory environment. 1998-99. Errors in both design and Various factors at the country's macro, meso implementation account for the reform's and micro levels block private investments in inability to accelerate private investment. RE-based power generation. Table 1.1 gives Design criteria, which should have included examples of these causal factors. increasing Nicaragua's rate of rural 5The last RE investment dates to 1992, when a sugar plant added more bagasse-fired, power generation capacity. 3 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua Table1.1:Nicaragua'sBusinessEnvironmentforPrivateREInvestment Level Obstacle Macro ­ Continued deep political divisions following a legacy of civil war ­ Political confrontations between President and Parliament ­ Low national income Meso ­ Power sector reform not customized to the national context of potentially competitive, RE-based generation Micro ­ Lack of national legislation to regulate productive uses of natural resources (for example water, national parks) ­ Vague laws for RE promotion ­ Weak capital market for project financing electrification and developing its rich RE value-added in power supply and accelerate the potential, took neither into account. Institutional country's national electrification rate and and financial arrangements to accelerate rural poverty reduction efforts. electrification were added as an afterthought (in 2006, the support structure was still The policies and instruments proposed are based undecided). The power market was not on a diagnosis of: designed to facilitate investments in RE generation, and the market scheme prevented · Postreform situation as it affects RE investments new RE generators from securing long-term and the macroeconomic consequences of the supply contracts on a competitive basis. current bias toward conventional power Unfortunate sequencing of implementation also generation in power-market arrangements; contributed to failure. For example, · Roles of power sector institutions and their privatization of the State-owned hydropower inter-relationships; holding company failed because key legislation · Specific needs of potential geothermal, had not been passed at the time of privatization. hydropower and wind farm projects; and In addition, the new private distribution · International lessons that apply to the company had difficulty fighting electricity theft Nicaraguan context. because the legal framework had insufficient instruments for punishing it (Box 2.3). Organization of this Report Study Focus The next Chapter provides an overview of Nicaragua's power sector, including the The purpose of this report is to propose sound implications of power sector reform, and the policies for overcoming perceived risks to future regional bulk market for RE investment. investing in Nicaragua's RE-based power Chapter 3 investigates the potential for generation as a means to reduce the cost of geothermal, hydropower and wind energy national power supply, increase national resources and their current status of 4 Introduction exploitation. In Chapter 4, Nicaragua's policy barrier of underinvestment in RE, and Chapter and regulatory framework for RE investment is 6 concludes. Annexes 1-3, respectively, cover explored, and critical building blocks for the RE legal and regulatory framework, a success, as well as policy gaps, are identified. diagnostic of its compatibility with the Chapter 5 then offers major policy initiatives proposed policy and international lessons in and a coherent set of strategies to break the RE frameworks. 5 2. Power Sector Overview In 2004, Nicaragua's total installed generation 200 MW RE plant cannot get full capacity capacity was more than 600 MW.6 Effective payments during initial years, but can sell its full generating capacity of power plants, which energy potential each year into the power pool; depends on seasonality (affecting hydroelectric diesel power plants cannot match the marginal capacity) and plant maintenance schedules, is short-term costs of RE plants. 450-490 MW. In 2003, peak demand was 435-440 MW and baseline demand 220-280 Installed Capacity and Potential MW. In 2002, consumption was 1,600 giga watt Nicaragua's 147-162 MW of RE power provide (s) per hour (GWh). From 1985 to 2001, about 30 percent of the country's available increased electricity consumption averaged capacity, a sharp decline from the more than 4.2 percent annually, while the population grew 60 percent provided in the early 80s and below 2.6 percent per year. The National Energy the Central American average of 41 percent. Commission (Comisión Nacional de Enegía ­ As of 2005, available installed capacity included CNE) expects an average growth rate of 4.4- biomass (108 MW),8 hydropower (98 MW) and 6.6 percent over the next decade, leading to an geothermal energy (37 MW) (Table 2.1). annual increase in required generating capacity of 30-50 MW. According to CNE's forecasts, As Table 2.1 illustrates, installed RE capacity base load in 2013 could run 675 MW, with amounts to only 8 percent of Nicaragua's peak system demand of 850 MW. economic RE power potential of 3,000 MW: hydropower (1,700 MW), geothermal RE Share in Electricity Generation (1,000 MW), wind farm (200 MW) and While demand growth is not ideal for planning biomass (100 MW). and implementing investments in large-sized RE Price Competitiveness power plants, it is large enough to make them economically feasible if an appropriate RE's decline in market share is not caused by a framework is established.7 For example, a lack of price competitiveness. In Nicaragua, 6Since a high share of generation is derived from older high-maintenance thermal plants, underperforming geothermal resources, seasonal hydroelectric plants and cogeneration sugar refineries, there is some uncertainty about available capacity. 7Near-term demand for annual capacity additions are lower; in early 2004, Union Fenosa, the privatized distribution company, indicated it needed 20 MW of new generation by November of that year and an additional 20 MW in 2006. 8San Antonio and Timal biomass-based power plants produce for the National Interconnected System (SIN) during harvest time, when they provide peak load capacity. San Antonio is owned by Sugar Estates, Ltd., a Nicaraguan company that has participated as a cogenerator since 1992. Currently, it has a 38 MW installation, of which 15 MW are for plant processes and 23 MW for sale to bulk power market brokers. 7 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua Table2.1:REShareinNationalPowerSupply,2005 Installed Economic Generation Capacity Potential (3,013 GWh) (percent) Power Supply Source MW MW Percent (available MW Percent (nominal) (available) capacity) Bunker Oil and Diesel 439 384 61 NA 65 Hydropower 104 98 16 1,700 14 Geothermal Energy 88 37 6 1,000 9 Biomass 127 108 17 100 12 Wind Energy NA NA NA 200 NA Total 757 627 100 3,000 100 Source: National Energy Commission. Note: NA = Not applicable. thermal power is the key determinant of the bulk · Hydropower. Several potential ROR plants power price; thus, bulk power is a good proxy for are believed to have production costs below the cost of conventional power production. From US¢6 per kWh. November 2000 to June 2003, the average bulk power price varied between US$60 and US$71 Iftheeconomicandfinancialvalueoflong-termprice per MWh;9 the average price was US$73 in stabilityiscorrectlypricedintotheevaluationofPPA offers­accountingfortheportfoliovalueofnew 2004, US$88 in 2005 and US$98 during the first geothermal,hydropowerandwindenergyplants­RE three months of 2006. powerplantsbecomeevenmoreprice-competitive Compared to these prices, at the level of required thandieselandheavyfueloil (HFO)-firedplants.10 long-term power purchase agreement (PPA) Power Sector Reform tariffs, new RE projects would, in principle, be price-competitive, as follows: In 1998-99, Nicaragua adopted and implemented a liberalized framework for the organization and · Geothermal. San Jacinto's PPA price (including regulation of its power industry. Through laws, drilling, field development and operation, and presidential decrees and regulations, the 1998-99 power plant construction) is US¢5.95 per kWh. power sector reform abolished the previous State To be commercially viable, future large monopoly of the vertically integrated Nicaragua projects will require US¢6.5-7 per kWh; Electricity Company (Empresa Nicaragüense de · Wind Farm: With competitive project financing, Electricidad ­ ENEL) (Box 2.1). Split horizontally production cost at the better sites is and vertically, ENEL was transformed into a State- US¢5.4-6.6 per kWh at year 2004 wind owned holding company. In addition, a bulk power turbine prices; and market was established. 9Over the same period, the spot price, a component of the total bulk power price, varied between US$34 and 59 per MWh (averaging US$46.5 per MWh). 10The term portfolio theory refers to the value of protection against fuel price fluctuations offered by the long-term fixed prices of PPAs signed with RE generators. For detailed discussion, see Awerbuch and Berger (2003); M. Bolinger, R. Wiser and W. Golove (2004). 8 Power Sector Overview Box2.1:LegislativeFrameworkforPowerIndustry The primary legislative framework for Nicaragua's power industry consists of parliamentary laws and presidential decrees (Annex 1). The most important are: · Law No. 272, 1998. Electricity Industry Law (LIE). Defines the specific regulatory framework and industry structure for the power sector; and · Law No. 271, 1998. Reform of the Founding Law of the Nicaragua Energy. Institute (INE) (Ley de Reformas a la Ley Organica del Instituto Nicaragüense de Energía). Details INE functions and administrative set-up. · Presidential Decrees 42-1998 and 128-1999, LIE Regulation. Defines the process for ENEL privatization. Secondary legislation, in the form of "normativas" issued by INE, establishes rules for sector operations. Isolated grid systems could still be served by the Generation, SA (Generadora Eléctrica Central, vertically integrated entities. But, within the National SA ­ GECSA ) was assigned the city of Managua's Interconnected System (Sistema Interconectado two largest diesel power plants: Planta Las Brisas Nacional ­ SIN), ownership of generation, (66 MW) and Planta Managua (57 MW); however, transmission and distribution was vertically they failed to attract any bid. separated, except that distribution companies could own up to 10 MW of generation capacity. Nicaragua's two large hydroelectric plants, Plantas CentroAmérica and Santa Bárbara, were folded While transmission and system operations were into the asset base of the Hydroelectric Generation retained as a State activity, ENEL's generation and Company (Generadora Hidroeléctrica, SA ­ distribution assets within SIN were to be privatized. HIDROGESA) and put out for public bid. However, ENEL was to be the power supplier of last resort the privatization ran afoul of a political process when no other economic agent was interested, as and Supreme Court litigation over assigning of well as the holding company for generation assets water rights. The National Assembly has, by Law not sold to private investors and of the National 440-03, stalled further privatization and Electricity Transmission Company (Empresa assignment of hydropower concessions until Nacional de Transmisión Eléctrica, SA ­ ENTRESA). adoption of the new Water Rights Law. Separation of Generation Assets In 1999, the Momotombo geothermal field and power plant were semi-privatized. Through an To create a competitive power generation structure international solicitation process, ENEL requested for bulk market bidding, ENEL's generation assets public bids to acquire a 20-year concession to were separated into various new companies. El expand and operate both. The only company to Paso Energy, through Coastal Power, its associated successfully tender an offer was Ormat, a private subsidiary, bid-on and-acquired Western Electric geothermal development company from Israel. Generation, SA (Generadora Eléctrica Division of Distribution Occidental, SA ­ GEOSA ). GEOSA had been assigned assets of the two ENEL-owned northern At the outset of power reforms, the sector-reform diesel power plants: Planta Chinandega (15 MW) committee divided Nicaragua's distribution and Planta Nicaragua (100 MW). Central Electric geographically: 9 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua · Western. The most developed region (with 85 Transfer of Transmission percent of the total population), the western system was divided into two concessions: The transmission system, formerly ENEL-owned Northern Distribution Company (Distribución and - operated, was transferred to ENTRESA, de Electricidad del Norte, SA ­ DISNORTE) which will remain in State hands; however, private and Southern Distribution Company owners and operators can build and own new (Distribución de Electricidad del Sur, segments of the transmission network. Through its SA ­ DISSUR) ; and National Load Dispatch Center (Centro Nacional · Eastern. To facilitate privatization, the eastern de Despacho de Carga ­ CNDC), ENTRESA is the system was not made a concession area, but national dispatch center, system operator for SIN may be served by any business entity, including and administrator of the spot power market. The the local government. National Operating Council (Consejo Nacional de Operación ­ CON), comprises of stakeholder Union Fenosa successfully bid on both the representatives, plays an advisory role to CNDC DISNORTE and DISSUR distribution systems.11 and National Energy Institute (Instituto While Union Fenosa fulfilled its connection Nicaragüense de Energía Nacional ­ INE). obligations, thereby assisting in raising the national connection rate, it has thus far been The transmission tariff uses "postage-stamp" unable to solve the inherited problem of high pricing. In 2004, at voltage levels equal to or system losses and insufficient bill collection higher than 69 kilo volt (kV), the transmission tariff rates. System losses persist, in part, because of was US$4.3 per MWh. The postage-stamp structural factors beyond the management's approach helps RE competitiveness because immediate control; these include: 1) an potential RE generation tends to be disperse and entrenched consumer culture of electricity theft; remote from consumption centers. 2) a culture of corruption among staff taken over; and 3) lack of legal instruments allowing Bulk Power Market a distribution company to take appropriate action against electricity theft. Consumers whose demand is larger than 2 MW (decreasing to 1 MW by 2007) can purchase Union Fenosa's regulatory contract and approved power directly from the bulk power market, average tariff were based on system losses organized as follows (Figure 2.1): substantially below the 35 percent it now incurs; the resulting losses undermine the company's · Bilateral PPA contracts between generators and financial situation. For generators signing PPAs consumers; and and banks financing investments in new · CNDC-operated spot market, which (like the generation, Union Fenosa's weak financial PPA contracts market) prices energy and situation poses a significant off-take risk and, capacity separately.12 hence, a bankability problem. The risk premium, added to the project lending rates, undermines The average price of the PPA contracts and spot the competitiveness of capital-intensive, RE-based markets yields the bulk power market's kWh investments, in generation. monomial price (precio monómico), which 11Sale was completed in October 2000 at a price of US$115 million, some US$14 million more than the established base price. 12According to the current Nicaraguan market rules, intermittent sources of power supply, such as wind energy, are not entitled to a capacity payment in either the contracts market or short-term capacity market, which is settled daily. 10 Power Sector Overview Figure2.1:OrganizationoftheBulkPowerMarket by tender in order for INE to accept contract prices for inclusion in the regulated retail tariff. PPA tenders are based on quoted MW and MWh Bulk Power Market prices, split into fixed and variable costs. Bids from thermal power producers include automatic adjustments for movements in imported Spot Market PPA Contracts Short-term (energy) Market Market fuel prices. (capacity) Because of Union Fenosa's demand-side dominance, Nicaragua's power market is best distributor Union Fenosa can pass on to final described as a monopsony.15 In 2004, only five consumers through its tariffs. independent power consumers ­ two large cement plants, El Limón mine, Managua Between November 2000 and June 2003, prices brewery and City of Managua ­ used more than were US$34-59 per MWh for the spot market 2 MW of electricity demand. The free market (averaging US$46.5 per MWh) and US$60-71 for selling directly to the 23 large consumers per MWh for the monomial price. In April 2004, with power demand greater than 1 MW when the average annual capacity price was amounts to 47.3 MW or 9.3 percent of power US$215 per MW, the average monomial price in the SIN. If this large-consumer classification was about US$60 per MWh. were reduced to 0.5 MW, the size of the free market would increase further. Market operation rules require power supply generators to provide a spinning reserve equal to The transaction costs of signing power supply 5 percent of their dispatched capacity.13 If they contracts with individual generators are large lack such capacity, they must contract capacity for the 0.5-1.0 MW category of potential large equal to 5 percent of the daily generation. consumers. Only in exceptional cases will they have the sophistication to begin trading on the The small size of Nicaragua's power market, Central American Electric Interconnection combined with the need for a certain amount of System (SIEPAC) regional market. Thus, if the liquidity on the short-term market to ensure eligibility limit is lowered, most of these efficiency, led to adopting market rules biased consumers, as well as several in the 1-2 MW against concluding long-term PPAs. Distribution category, will likely retain their contracts with company licenses require these at the end of the Union Fenosa. year so that PPA contracts equal a minimum of 80 percent of their forecast demand for the next year Design of Nicaragua's bulk power market has and 60 percent for the subsequent year.14 three major implications for investments in RE- Distribution companies must secure PPA contracts based generation: 13The CNDC's goal is a minimum of 5 percent rolling reserve and 2.5 percent regulatory reserve (Article TOC 9.81, business operational rules). Currently, without hydropower plants generating, achieving the regulatory reserve of 2.5 percent is not possible. 14To facilitate the privatization of generation companies, Union Fenosa had, during its first year of operations in Nicaragua, about 80 percent of the nation's generation capacity under PPA contracts for more than two years. But the PPAs were so structured that, with each subsequent year, the take-or-pay capacities for sale under long-term fixed pricing decreased. 15The term monopsony refers to a market in which products of several sellers are sought by only one buyer. 11 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua · The bilateral contract market (except for small consumers; and 2) high to low monthly RE projects) mainly concerns negotiating a PPA consumption households. with Union Fenosa; thus, off-take credibility of this distributor is a key issue for lenders; The residential tariff policy applies a lifeline rate · The market scheme's short-term bias makes it with six stepwise increases (Figure 2.2). The difficult for generators to acquire long-term lowest rate applies to the first 25 kWh of monthly contracts (except for low-cost RE projects), consumption, while the highest applies to which seriously handicaps RE project consumption above 1,000 kWh per month. In financing; and May 2004, households in Union Fenosa's · During PPA tender evaluation, RE-based bids distribution network paid US¢0.05 per kWh for do not receive premiums for long-term the first 25 kWh and US¢0.27 per kWh for price stability; thus, tenders disregard a consumption above 1,000 kWh per month. major competitive advantage of RE- The redistributive effect of the lifeline policy is generated power. largely regressive; that is, 98 percent of residential consumers receive their supply Retail Tariffs and Cross-subsidies below cost, while 45 percent of households remain without electricity. The Electricity Act of 1998 and INE regulations stipulate that Union Fenosa's tariff structure will Excessive-cross subsidy in the household not cross-subsidize between business and consumer category, resulting from the high household consumers. But because Union number of steps, reduces the scope for urban-to- Fenosa's tariff schedule applies to all consumers rural cross-subsidy. This, in turn, reduces the within its distribution network, in practice, two financial scope for rural electrification below types of cross-subsidy occur: 1) urban to rural the feasible level and, thus, the number of small- Figure 2.2: ResidentialTariff Structure, 2004 (US$ per kWh of monthly consumption) 0.30 0.25 0.20 0.15 US$kWh 0.10 0.05 ­ 0-25 25-50 50-100 100-500 500-1,000 1,000 and kWh/Month Above Sources: National Energy Commission, Synex Consulting Engineers and Gerens (2004). 12 Power Sector Overview scale RE systems that would otherwise have electrification. Outside the energy sector, but been installed. severely affecting the ability to implement hydropower projects, a battle between the Public Governance ministries of industry, agriculture and CNE and INE share public governance functions environment over the institutional authority in for Nicaragua's power sector (Box 2.2).16 Since assigning and regulating water rights, is holding reform, these policy and regulatory institutions up progress in adoption of the draft Water Law have voiced their differences on various issues. (Ley de Aguas). Such turf battles have increased For example, they differ on the regulatory investment risk and hurt promoters' ability to implications of public subsidies given to rural plan and implement projects. electrification investments when Union Fenosa takes over these assets. Such disagreement The strained relationship between President impedes a coherent approach to rural Enrique Bolaños, elected in 2002,17 and the Box2.2:InstitutionalRolesandResponsibilities The 1998-99 reform process created new institutions and redefined the roles and tasks of existing ones. The Electricity Act of 1998 divided the public-governance functions for the power sector between two institutions: · National Energy Commission. CNE is responsible for formulating sector policies, preparing national- and rural-power expansion plans, proposing energy sector laws and presidential decrees and implementing rural electrification projects. Thus, CNE's role now extends beyond electrification to responsibility for government strategic planning on all energy issues; and · National Energy Institute. INE is responsible for issuing technical sector regulations and licenses and concessions for the power sector and petroleum industry. INE approves investment plans of licensed power companies. (Each year, ENTRESA, the national transmission company, presents INE its investment plan for approval; INE makes a decision after receiving the opinion of the CON.) INE also approves the power tariffs of transmission and distribution companies and monitors quality of all electricity sector service providers. INE's former responsibility for energy-sector strategy and policy was transferred to the CNE to enable INE to focus exclusively on its new role. 16As a new institution, CNE assumed responsibilities that formerly belonged to INE, which had seen its pre1998 powers severely curtailed by the reform. When INE was created in 1979, it combined the functions of the Ministry of Energy with those of the national power and oil companies. INE operated power sector enterprises and supervised activities in the hydrocarbon sector. In the mid-90s, INE was still the lead governmental institution in the energy field, playing the role of regulator of energy utilities, planner of energy development and environmental control and potential purchaser of private wind farm output. 17In 2001, the Constitutionalist Liberal Party (PLC)'s Enrique Bolaños won the presidential election with 56.3 percent of the vote. President Bolaños lost support of the PLC in January 2002 when his government decided to take legal action against former President Arnoldo Alemán, who ruled Nicaragua from 1997 to 2002. In December 2003, Alemán was sentenced to 20 years in prison for fraud, money laundering, embezzlement and corruption. 13 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua National Assembly prevented implementation of a country's western and eastern geographic regions. new law, adopted in 2005, which created the These are: Public Utility Superintendency as the regulatory authority for telecommunications, energy, water · PLANERAC. Electrification Plan in and sewage, eliminating sector regulators Concessioned Areas (Plan Nacional de TELCOR, INE and Nicaraguan Sewerage ansd Electrificación Rural para el Area Aqueduct Institute (INAA).18 President Bolaños Concesionada). Held by Union Fenosa, the refused to accept the legality of the law and western (concessioned) area had an Parliament's appointment of the superintendent electrification rate of 60 percent in 2003. The and four commissioners.19 plan is needed because, according to the terms Organization of Rural Electrification of the sale agreement for the two distribution areas taken over by Union Fenosa, the Nicaragua's Rural Electrification Policy aims concessionaire is not responsible for providing to increase the national electrification rate to electricity service to regions outside the 71 percent by the end of 2013.20 Electricity concession area. CNE uses a set of well- will be provided to 1.6 million currently defined, project selection criteria. Projects must unserved residents, at a total estimated cost of be included in both the national development US$300 million.21 plan (PND) and municipal development plan (PMD), investment costs must be under CNE Planning and Implementation US$1,000 per connected consumer and the The Electricity Act of 1998 makes CNE the inter- tariff must cover Operations and Maintenance institutional entity responsible for promoting and (O&M) costs; and implementing electrification in areas where · PLANER. National Rural Electrification Plan commercial agents show no interest in providing (Plan Nacional de Electrificación Rural). The service. As rural electrification planner, CNE is eastern (nonconcessioned) area, located along responsible for: the Atlantic Coast,22 had an electrification rate of 22 percent in 2003. The plan is divided into · Defining policy; Five-Year Plans (2004-08 and 2008-13). CNE · Preparing plans; project selection criteria are less specific; they · Securing financing from bilateral donors and follow PND directives, which seek to develop multilateral development banks; and productive clusters (small geographic · Identifying,preparing;andimplementingprojects. agglomerations of enterprises and institutions) Because of separate institutional conditions, CNE to serve as service centers and development must prepare two rural electrification plans for the poles for the surrounding area. The emphasis 18Ley de la Superintendencia de Servicios Públicos (No. 511-2006). 19The point of contention was not over the value of the Superintendency ­ it makes good sense in view of the scarcity of regulatory expertise and the tendency of utilities to spread across several sectors ­ but with regard to the National Assembly's appointment of the Superintendent of Public Services and the Commissioners for Energy, Telecommunications, Potable Water and Sewage. 20Rural electrification policy is important for RE investments; indeed, RE-based generation is often the least-cost solution to supply power for new rural distribution areas. 21The 2005-06 program foresees investments of US$49 million to electrify 45,000 households; until 2013, annual financing of US$20-30 million will be needed to reach the target. 22The nonconcessioned area includes the two autonomous regions (North Atlantic Autonomous Region [Region Autónoma Atlántico Nord ­ RAAN] and South Atlantic Autonomous Region [Region Autónoma Atlántico Sur ­ RAAS]) and portions of five departments: Jinotega, Matagalpa, Boaco, Chontales, and Río San Juan. 14 Power Sector Overview is on finding areas with productive use RAAS, and central and northern regions, using potential, population with a willingness-to-pay diesel generators. and potential for RE use. Financing Policy Rural electrification in Nicaragua is understandably complex. CNE must play multiple roles, its Financing policy for rural electrification involves: responsibilities regarding rural concessions overlap 1) identification and securing of project financing with those of INE, and the issue of "concessioned" sources (for example, consumer cross-subsidies and versus "nonconcessioned" areas is complicated. In State budget allocations from domestic and donor addition, funding from multiple sources is funds); 2) division of project finance between uncertain, and essential ownership and regulatory investor equity, debt finance and subsidy; and issues (for example, rural tariff policy) 3) level of cost coverage through rural power tariffs. remain unclear. In 2005, these financing issues, including the level CNE's Rural Electrification Administration of subsidies to individual projects, were still (Dirección Electrificación Rural ­ DER) acts as the decided on an ad hoc basis. The 1998 Electricity executing agency for rural electrification projects Act referred to the establishment of the National financed by foreign donors and multilateral Electricity Development Fund or (Fondo de development banks. The DER's negotiations with Desarrollo de la Industria Eléctrica Nacional ­ Union Fenosa are difficult regarding projects FODIEN) to cofinance rural electrification extended from concessioned areas. Union Fenosa projects under CNE-initiated programs. FODIEN engages in DER programs only reluctantly,23 cofinancing could be in the form of loans, requiring that the entire capital cost of new subsidies or both. The Electricity Act established that the rural electrification program was to be projects be covered by subsidy and that it be given financed through annual budget allocations. management authority for all aspects of project development and construction. DER has itself Thus far, the State has not allocated any funds to implemented projects that it subsequently handed FODIEN. As mentioned earlier, the DER has taken over to Union Fenosa. on the role of executing agency for rural electrification projects financed by foreign donors In principle, any entity can identify, prepare and and multilateral development banks. The most undertake rural electrification projects in the important are: nonconcessioned area. In practice, however, DER initiates most projects.24 ENEL acts as power · Rural Energization Development Strategy and supplier of last resort (when no other economic Pilot Plan for Nicaragua, Inter-American agent is interested). It holds concessions for Puerto DevelopmentBank; Cabezas and Bluefield in the eastern region; in · Rural Electrification Program in Isolated Zones, nonconcessioned areas, it provides electricity The World Bank; service through 32 isolated grids in the RAAN, · Small-scale Hydropower Development for 23Like many other recently-privatized distribution companies in Central America, Union Fenosa focuses mainly on improving its commercial and administrative systems and ensuring it can profit from areas it already serves; see Barnes and Waddle (2004). 24DER also implements and operates projects in the nonconcessioned area; however, it plans to shift to a facilitation role, serving as a secretariat for the National Electricity Development Fund (FODIEN), with local communities and private investors undertaking project preparation and implementation. 15 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua Productive Uses in Off-grid Zones, United over by Union Fenosa. INE insists that they should Nations Development Programme; and be treated as loans, meaning that Union Fenosa · Atlantic Coast Electricity Development would repay the full amount through increases in Program, Central American Bank of its average tariffs. Economic Integration. Failed Reform and Political Risk The growing need for electricity service in eastern nonconcessioned areas has required the Investor confidence has diminished as a result construction of more ENEL-operated small power of the failed power sector reform (Box 2.3). plants. In recent years, ENEL has installed more The economic incentives provided under Decrees than 30 diesel-powered plants; they are reliable 12-2004 and 13-2004 cannot outweigh the but expensive, requiring regular maintenance. negative effect of risk premium on the cost of ENEL has drawn on profits from operation of its capital (Annex 1). hydropower plants to cover losses on rural electrification projects. The two major consequences of failed reform are that: Cost recovery and rational tariff design are key to achieving sustainable rural electrification in · Union Fenosa, the distribution company, is not Nicaragua. But tariffs are not yet differentiated by a credible off-taker for long-term PPAs; and geographic region, and ENEL and CNE disagree · New investments in geothermal and on how to treat FODIEN funding for projects taken hydropower face regulatory and planning Box2.3:WhyDidPowerSectorReformFail? The 1998 Electricity Industry Law (Reglamento a la Ley de la Industria Eléctrica) failed to achieve its aims. The desired horizontal separation of distribution was not attained as distributor Union Fenosa won the tender for both concessions of the national grid system. The Nicaraguan government was unable to sell all State-owned generation assets, and Union Fenosa did not manage to reduce large system losses in distribution. As a result, the power sector attracted little private investment. As an instrument for achieving key energy policy objectives, the reform was poorly designed. Measures to accelerate rural electrification were not integrated into the reform process, and market arrangements were not developed to favor new investments in RE generation. Despite the overwhelming scope for cost-effective RE investments, the reform failed to put a framework in place to allow new RE generators to secure long-term supply contracts on a competitive basis. And, despite low rural electrification rates, the power sector did not cater to its financing and institutional needs. Sequencing in implementation was also unfortunate as certain key legislation had not been adopted at the time of privatization. For example, privatization of HIDROGESA failed because the new Water Rights Law had not been passed. Union Fenosa had difficulty fighting electricity theft because the legal framework lacked sufficient instruments for tackling cases of electricity theft. 16 Power Sector Overview hurdles (for example, the better geothermal financial outlay to protect investing and doing sites are located on land to be declared business in a particular country). Since most national parks, and hydropower investments developers must insure both project debt and await clarification on the new Water equity for political risk ­ representing a 15-25 Rights Law). percent premium onto the weighted average cost of capital for a project ­ the fixed costs of RE Risk Premiums generation are raised substantially. The resulting political risk greatly affects production costs. To finance offshore wind farm The effect of a 4 percent increase in the interest development projects, for example, banks add a rate depends on the maturity of debt financing 4 percent risk premium to their interest rate if the (Table 2.2). In addition, one can distinguish developer opts for a new turbine technology with between the increase in required tariffs during the a short operational track record. For 50 MW amortization period and the effect of production geothermal plants, annual risk premiums can run costs over the 25-year economic lifetime as high as US$5 million (an extremely large of a plant. Table2.2:RiskPremium'sEffectsonCostofCapitalandGeneration* Project-type Financed Debt Financing Wind Farm Geothermal Hydropower (US$ per kWh) (US$ per kWh) (US$ per kWh) 10-year Loan First 10 Years 0.49 0.49 0.75 Lifetime Cost Increase 0.25 0.25 0.39 15-year Loan First 15 Years 0.50 0.50 0.77 Lifetime Cost Increase 0.36 0.36 0.55 Source: Author's calculations. *Based on a 4 percent risk premium. Table2.3:EffectsofLoanMaturityonGenerationCost Plant-type** Loan Maturity Geothermal Hydropower Wind Farm (10 percent interest)* (US¢ per kWh) (US¢ per kWh) (US¢ per kWh) 15-year 1.8 2.8 1.8 10-year 2.5 3.8 2.5 Source: Author's calculations. *Loan represents 70 percent of investment. **Geothermal (US$2 million per MW, 80 percent capacity factor), hydropower (US$2.5 million per MW, 65 percent capacity factor) and wind farm (US$1 million per MW, 40 percent capacity factor). 17 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua Immature Capital Market · Regional Electric Power Interconnection Commission (Comisión Regional de In addition, an immature capital market Interconexión Eléctrica ­ CRIE) ­ wholesale reduces the length of maturity on project loans. market regulator; and For example, a reduction from 15 to 10 years · Central American Market Operator (Operador adds US¢0.07 to the cost coverage tariff of a del Mercado Centroamericano ­ OMCA) ­ geothermal power plant and wind farm and US$1 administrator of regional power transactions. to the tariff of a hydropower plant (Table 2.3). The upcoming regional power pool increases Thus, in a country with a perceived high-risk investor interest in two ways: 1) the larger-scale environment, the combined effects of lower regional market allows for building larger maturities and higher risk premiums on loan power plants; and 2) regional competition for capital can easily increase the required tariff from attracting generation projects reinforces investor US$1.4-1.6 per kWh. confidence in the predictability of national regulatory frameworks. Regional Power Market For Nicaragua, opening up national markets to SIEPAC entails the construction of transmission increased cross-national power supply provides both lines connecting 37 million consumers in Costa opportunity and risk. While the country stands to Rica, El Salvador, Guatemala, the Honduras, benefit from new RE investments, a regional market Nicaragua and Panama.25 Costing an estimated poses the threat that power sector investments may US$320 million, SIEPAC was scheduled for be redirected to neighboring countries. Investors in completion in 2006. Mexico is linked to SIEPAC generation will focus on those countries that offer the through the 100-km, 400-kV transmission line best conditions in terms of :1) RE resource quality; constructed between Tapachula (Mexico) and 2) efficiency of sector regulations and project Los Brillantes (Guatemala) substations, while approval procedures; and 3) generosity of fiscal and Belize is linked by the 195-km, 230-kV power other economic incentives. transmission line between Santa Elena Competition in improving the regulatory (Guatemala) and Belize City (Belize) substations framework benefits all countries and stakeholders (DOE 2003). in the region. Competition in offering investors economic incentives in generation is a zero-sum These investments will permit the creation of a game: total supply is defined by the regional Central American wholesale power market. demand for power and, therefore, not affected by According to the Framework Treaty for the sector-specific economic incentives. The result is a Central American Electricity Market (Tratado sub optimal sharing of resource rents between Marco del Mercado Eléctrico de América risk-taking investors, power consumers and State Central) and the Transitional Regulation of the budgets. Therefore, the Nicaraguan government Regional Electric Power Market (Reglamento will discuss with other governments in the region Transitorio del Mercado Eléctrico Regional),26 how incentive regimes and policies can be two regional institutions will be created to regionally coordinated to prevent an govern this power market: "incentive-maximizing" race. 25In 2002, the region's total population was 73 million; electrification rates were 95 percent (Costa Rica), 84 percent (Guatemala), 83 percent (Panama), 78 percent (El Salvador), 63 percent (Honduras), and 47 percent (Nicaragua). At the end of 2003, installed generating capacity was 8 gigawatt (GW), comprised of fossil fuel (45 percent), hydropower (45 percent), geothermal (5 percent), bagasse cogeneration (4 percent) and wind energy (1 percent). 26Motivated by completion of the El Salvador-Honduras link. 18 3. Resource Potential and Exploitation Status Resource Potential RE resources allow for the development of base- and peak-load plants, as well as CNE studies estimate Nicaragua's economically intermittent power supply. viable RE resource potential at 3,000 MW, composed of 1,700 MW hydropower, 1,000 MW Geothermal Energy geothermal energy, 200 MW wind energy and 100 MW biomass-based power. This quantity is five CNE's Geothermal Master Plan of 2001 times higher than the 2004 national power capacity. projects that Nicaragua has nearly 5,500 MW of geothermal reserves. Of these, 303 MW are As the following sections illustrate, the quality of reservoirs established as proven reserves, Nicaragua's RE resource potential is equally 802 MW are probable reserves, and a impressive. The cost of production is price further 4,375 MW are possible reserves competitive with diesel power plants. In addition, (Table 3.1).27 Table3.1:GeothermalResourceProjectionsforNicaragua Area Proven Probable Possible Commercial Reserves Reserves Reserves Development (MW)1 (MW)2 (MW)3 (in 10 years) El Hoyo-Monte Galán ­ 148 491 50 Managua-Chiltepe ­ 113 337 0 Masaya-Granada-Nandaime ­ 172 1,285 50 Momotombo 142 ­ 190 50 Ometepe ­ ­ 584 5 San Jacinto-Tizate 161 ­ 207 150 Tipitapa ­ 18 ­ 0 (Continued...) 27Proven reserves are geothermal resources already encountered in commercial quantities by the drilling of deep exploration and production wells and extensively tested via extended time reservoir production. Probable reserves are calculated based on extensive geological, geophysical and geochemical data and surveys, combined with possible test wells; generally, there is enough geological and exploration data in such areas to have already targeted locations for at least the first deep exploration wells. Possible reserves are based on sound geological principles, combined with a certain degree of geophysical and geochemical testing and often nearby active volcanic activity (they are the least reliable form of projection). 19 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua (...Table 3.1 continued) Area Proven Probable Possible Commercial Reserves Reserves Reserves Development (MW)1 (MW)2 (MW)3 (in 10 years) Volcán Casita-San Cristóbal NA 224 676 50 Volcán Cosigüina NA NA 425 0 Total 303 675 4,195 355 Total Power: 5,508 Source: Global Power Solutions (2006). Note: NA = Not applicable. Potential Contribution to Growth power could, in principle, account for 250-400 MW of growth over the coming decade. Geothermal resources account for only 30 MW of the electricity generated, a fraction of the Operating Mode and Production Costs estimated 1,200 MW of economically exploitable potential (Figure 3.1). Eight of the nine economically Geothermal power plants are base-load plants viable project sites are larger than 100 MW. To be for reasons of cost and reliability. They have implemented, such plants must attract foreign high fixed costs in terms of the ratio of the investors. But based on these resources, geothermal cost of investment versus per kWh of output Figure3.1:DistributionofGeothermalEnergyPotential Geothermal 13o00' Matagalpa Potential Volcan Cosiguina Area MW Volcan Casita-San Cristobal Casita-San Cristobal 224 Chinandega Volcan Telica-El Najo Volcan San Jacinto-Tizate Telica-EL Ñajo 127 Volcan EL Hoyo-Monte Galan Leon Volcan Momotombo San Jacinto-Tizate 161 Tipitapa Hoyo-Monte Galan 148 12o00' Managua Managua- Momotombo 142 Chiltepe Masaya-Granada- Nandaime Managua-Chiltepe 107 Lake Tipitapa 18 Isla De Ometepe Masaya-Nandaime 174 Ometepe 100 Pacific Nicaragua Total 1,200 Ocean Source: National Energy Commission. 20 Resource Potential and Exploitation Status to the operating costs per kWh and the small, large and mega sites of 150 MW and above. ratio of fixed operating costs to those that vary with daily MWh of production. Year-round The CNE inventory of 104 hydropower projects reliability is high, with capacity factors easily comprise 30 potential projects in the mini market above 85 percent. segment (100 kW-1 MW), 36 in the small segment (1-25 MW) and 38 in the medium- and The production cost of future geothermal power large-scale (mega) segment (25 MW and above). plants (or PPA tariff, which would have to be paid) The hydropower potential of these projects are is US$6-7 per kWh at the plant site.28 estimated at 3,282 MW (Table 3.2). Hydropower Potential sites above 10 MW are well- documented by resource and feasibility studies. Nicaragua's identified hydropower potential is As shown in Table 3.2, they represent nearly 3,760 MW, of which 1,700 MW (with an annual 98 percent of identified MW potential. generating potential of 6,600 GWh) are considered The economic potential of 1,767 MW comprises economically feasible. This amount is four times the 13 sites, ranging from 17 MW (Larreynaga) to 2003 electricity consumption of 1,650 GWh. 425 MW (Tumarin) (Figure 3.2).29 Site Potential and Inventory Hydropower potential below 10 MW is estimated Possible hydropower sites range from "pico" and at 165 MW. But the 2-10 MW range has not been "nano" sites (of only a few kilowatts) to micro, mini, assessed systematically. Table3.2:EstimatedPotentialofIdentifiedHydropowerSites Capacity Identified Site Distribution Total Estimated Size Distribution Range (MW) Sites (No) (percent) Capacity (MW) (percent) 0.1-1* 30 28.85 10 0.30 1-10** 14 13.46 60 1.83 10-25** 22 21.15 416 12.68 25-272** 38 36.54 2,796 85.19 Total 104 100.00 3,282 100.00 Source: Author's data compilation based on CNE hydropower inventory, IFC study and other documents. * UNDP-supported mini hydropower projects include El Bote and El Ayote (PERZA). **Based on CNE inventory and studies (Wilwili, Salto Grande and Siempre Viva). 28Ormat International is the concession holder of Momotombo, Nicaragua's only operational geothermal power plant. Ormat's price at the plant meter is US$4.5-4.8 per kWh. However, at the time Ormat entered into the contract, the project contained no substantive resource or development risk as Ormat took over a constructed operational field and plant. The PPA price of San Jacinto, a geothermal plant currently under development (including drilling, development and operation of a geothermal field and power plant construction), is US$5.95 per kWh; see GPS (2006). 29Potential projects (small-to-large in scale) that were the subject of update studies over the past decade are Mojolka (138 MW), Copalar (150 MW), Larreynaga (17 MW), Pantasma (24 MW), projects in the Upper and Lower Rio Viejo region (extension of the existing Central America Hydropower Plant [PCA] and Santa Barbara Plant [PSB]), and Y-Y River projects (estimated at some 27 MW). 21 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua Figure3.2:DistributionofNicaragua'sHydropowerPotential Hydropower Potential Range Project Basin Capacity Energy MW GWh 1 Tumarin R Grank 425 1,830 2 Mojolka Tuma 119 516 Pintada 3 Brito San Juar 260 1,138 Kavaska 4 Copalar Grande 281 1,164 Kuikuinita Paraska 5 Valentin Rama 62 270 Mojolka 6 Pintada Coco 203 835 Larrevnaga Tumarin Copalar 7 Kuikuinita Prinzapol. 63 277 Paso Real 8 Paraska Ivas 41 177 9 Kavaska Bocay 54 235 10 Larrevnaga Vieio 15 66 Valentin Piedra Fina 11 Piedra Fina Rama 102 437 12 Paso Real Grande 48 211 Tendido 13 Tendido Punta 94 411 Brito Gorda 1,767 5,767 Projects Source: National Energy Commission. Potential hydropower sites below 2 MW are well- they may produce at only a fraction of the documented thanks to the ongoing small hydro installed capacity. program (SHP) funded by the United Nations Development Programme (UNDP) and the Global ROR plants can be further subdivided into two Environment Facility (GEF), as well as the World market segments: 1) noncommercial micro hydro Bank-GEF supported PERZA program. Under the plants; and 2) mini hydro plants for rural PCH program, ATDER-BL, a Nicaraguan non electrification, which depend heavily on grant governmental organization (NGO), systematically support and commercial small hydro plants selling assessed 30 mini hydropower sites; the purpose to the national grid. was to determine their potential use in rural Micro hydro plants, defined as grid-connected electrification projects for power supply to isolated plants with less than 100 kW, can be used as or regional grids or a mixture of local and national stand-alone systems or for small-village grid grid supply. systems; therefore, they depend heavily on donor support. Key actors in this segment are NGOs and Mode of Operation and Market Segments Rural Electric Cooperatives (RECs). In terms of their power market application in Mini hydro plants, which range from 100 kW to Nicaragua, hydropower plants can be divided into 1 MW, mainly address the need for decentralized three categories: 1) ROR plants; 2) plants of up to rural electrification, although plants with capacities 25 MW; and 3) plants larger than 25 MW with toward the upper limit of the segment can also be year-round storage capacity. connected to SIN. Although Nicaragua lacks a complete inventory of mini hydropower sites, the ROR plants represent 15 percent of Nicaragua's locations of 30 mini hydro plants are listed for the economically viable, MW hydropower potential. project area of the PCH program. Their storage capacity is limited to daily peaking purposes. Their power supply is seasonally The small hydropower segment (1-25 MW) is intermittent. During the dry season, for example, meaningfully divided into three subsegments: 22 Resource Potential and Exploitation Status · 1-5 MW. This market subsegment, requiring An example is the Banco Uno and Coastal investments in the US$2-10 million range, falls Power consortium, which successfully under the favorable regulatory framework for participated in the HIDROGESA tender. small hydro projects of up to 5 MW. It attracts national investors who want to invest in The 25-150 MW+ segment (subdivided into Nicaragua, take a medium risk and do not wish medium- and large-scale hydro) are mega to enter transnational consortia. Even though projects for large international consortia. At the projects in this subsegment can be developed level of large hydro, mainly for export, Nicaragua relatively quickly, only seven have is likely to face strong competition from been identified; neighboring countries (that is, Costa Rica, · 5-15 MW. Projects in this range require Guatemala and Honduras). significant investment and a medium-term planning horizon (two to four years). Associated Wind Energy technical and economic risks are greater for these projects than for those in the 1-5 MW More than a decade has passed since Nicaragua's sub-segment, and banks are more reluctant to public sector invested significantly in collecting data finance them. These projects may attract joint on the country's wind resource potential. In 1995, ventures of national investors and foreign the National Rural Electric Cooperative Association business partners who wish to invest in (NRECA), under its Central America wind Nicaragua, but share associated risks with measurement program, partnered with INE to national developers. For this subsegment, the erect two wind masts with wind measurements of updated CNE inventory lists nine projects; and 15 and 30 meters. Since then, public sector · 15-25 MW. This subsegment includes large investment has been limited to national projects in the Nicaraguan context requiring a meteorological-service data. But four to five planning horizon of at least three to five years. private sector developers have invested in In past years, potential developers have shown measurements on promising wind farm sites. interest and acquired temporary licenses to develop such projects as Larreynaga and In consultation with these developers, CNE Pantasma. However, the country's unfavorable estimates that Nicaragua's high class, wind energy legal framework (for example, suspension of potential (that is, capacity factors greater than 35 the existing Water Law in 2002 and legal percent) will permit 200 MW to be installed. preference given thermal power generation) has blocked potential private investors from Estimated Production Cost progressing in project development, including privatization of the HIDROGESA plants. The Financial analysis (Jiménez and Povedano, updated CNE inventory lists 17 projects in this 2003), based on a 17 percent rate of return sub-segment. Potential developers include on equity, shows that the cost of wind farm consortia of national companies/banks and production in Nicaragua varies between US$50 foreign companies willing to invest in the and US$66 per MWh, depending on the resource US$30-50 million range of the power sector. quality, ability to sell certified emission 23 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua reductions,30 and introduction of the RE Project Experience proposed 10-year tax holiday for wind farm income (Table 3.3). The cost of production does Geothermal Projects not include the incremental cost of balancing the Plants in Operation system power to adjust for intermittent wind energy supply. Momotombo, whose field is located one hour northwest of Managua, is Nicaragua's only Scope for Grid Absorption operational geothermal power plant. The Intermittent power supply's effects on grid Momotombo field and plant have been in reliability, combined with the narrow gap between commercial production for the past 20 years. base load capacity and off-peak demand, mean During that time, more than 44 exploration wells that only a portion of wind power capacity can be have been drilled to depths of 2,500 meters, integrated into the grid. Over the next four years encountering temperatures in excess of 330°C. (2006-10), up to 60 MW of wind farm capacity But the plant's 70 MW of installed capacity has can be integrated into the grid system without never been reached for more than a few hours; significantly increasing operating costs. Penetration by the 90s, production declined to only 14 MW. In beyond that level would be uneconomic since 1999, Ormat International was awarded a power production from wind farms during some 20-year concession to operate and maintain both off-peak days would be higher than power the field and plant; it subsequently stabilized plant demand. In 2006, these 60 MW amounted to production at 30 MW. about 10 percent of peak demand and 20 percent Exploration Activities of evening demand, while the kilowatt-per-hour output represented 7 percent of the national Nicaragua's rich geothermal resources have power generation. attracted upfront investments from an array of Table3.3:EstimatedCostsofWindFarmPowerProduction Required Tariff (Average) Wind Velocity Plant Factor Generation Without CO2 With CO2 Plus Tax Holiday (average) (GWh) (US$ per MWh) (US$ per MWh) (US$ per MWh) 8.5 0.40 70.1 66.0 63.0 62.0 9.0 0.44 77.1 60.0 57.0 56.0 9.5 0.47 82.3 56.0 53.2 52.5 10.0 0.49 85.8 54.0 51.0 50.0 Source: Jiménez and Povedano (2003). 30A reduction of 0.8 tons CO2 per MWh at US$ 5 per ton CO2 yields a revenue of US$ 3 per MWh. 24 Resource Potential and Exploitation Status exploration companies. Major sites and Canadian company) was awarded an developers are: exploration concession for the San Cristóbal volcanic area. The developer already owned · El Hoyo-Monte Galán. TransPacific Geothermal and operated the nearby El Limón mine. was leased the El Hoyo-Monte Galán Triton Energy still holds the San Cristóbal concession in December 1995. The developer concession; and conducted extensive geological, geophysical · San Jacinto. This project may represent and geochemical studies throughout the Nicaragua's best opportunity to meet the concession area. In 1998, TransPacific entered government's interest in a geothermal into a joint venture with Calpine Corporation; component for the next 40 MW of new however, a PPA was never obtained and generation. The San Jacinto exploration financing never acquired. In December 2002, concession was originally issued to a Russian- INE withdrew the concession for lack Nicaraguan consortium in May 1993. That of development; consortium conducted extensive geological, · El Ñajo. In August 1997, Unocal, a major geophysical and geochemical exploration geothermal developer, was awarded the first activities, ultimately drilling seven deep exploration concession at El Ñajo. After two exploration wells (to depths of 2,335 meters years of exploration activities (and major with temperatures of 290°C). Long-term geothermal setbacks in Asia), Unocal returned reservoir testing on three of these wells proved the concession to the Nicaraguan government. the existence of a commercial reservoir In December 1999, SAI Geothermal was exceeding 25 MW. The San Jacinto-Tizate awarded the concession. After only one year, concession is now held by a Nicaraguan- SAI requested that it be expanded into areas Canadian consortium of investors (owners of within the San Jacinto concession. When INE Triton Energy) and Germany's Daimler denied this request, SAI voluntarily returned the Benz group. concession to the Nicaraguan government; · Managua-Chiltepe and El Hoyo-Monte Galán. Currently, the San Jacinto Power Company, SA In April 2006, Enel and LaGeo jointly signed has three shut-in geothermal wells on site. exploration contracts with INE to explore two These have been extensively flow-tested and areas of 100 km2 each, located in Managua- proven to have a combined production capacity Chiltepe and El Hoyo-Monte Galán.31 Two of more than 20 MW over a period of at least years of exploration activities will be needed to 30 years. San Jacinto, which already had a confirm geothermal generation potential, PPA, planned to have 10 MW on line by currently estimated at 100-200 MW. Over the December 2003, 22 MW by June 2004, and next two years, project investment will total ultimately 66 MW by 2006. Yet, for the past six US$15 million; years, construction has been delayed for lack · San Cristóbal. In August 1999, Triton Energy, of financing. The Nicaraguan government's SA (a subsidiary of Black Hawk Mining, a most important participation in geothermal 31Enel and LaGeo operate in Nicaragua through GeoNica, a dedicated joint venture with stakes of 60 percent (Enel) and 40 percent (LaGeo). Enel's extension of the Berlin power plant (with a 40 MW installed capacity) is scheduled to start operation in June 2006. That capacity will be conferred to LaGeo, and Enel will increase its stake. 25 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua energy may be to use multilateral grants and heavily on segments below 5 MW. These activities funding to acquire Phase-I turbine units of this are heavily donor-financed and mainly target use project and lease them to San Jacinto. in rural electrification projects. From the above list, one can note that substantial To date, Nicaragua has no specific program (at geothermal exploration activity has occurred over least, not covered by PCH or PERZA) to promote the past decade and continues. Investors have the systematic development of micro hydro plants. shown willingness to take on the risk of upfront Development in this sector is sporadic, and no investments in resource exploration. Yet, one also systematic site inventory has been conducted. notes that little follow-up implementation has occurred. Indeed, over the past several years, The PCH and PERZA programs attempt to develop more concessions have been returned to, than mini hydropower projects. Located in central issued by, the Nicaraguan government. Nicaragua, the PCH program reaches 90,000 rural families in 67 municipalities across eight Hydropower Projects departments (Madriz, Nueva Segovia, Estelí, Matagalpa, Boaco, Chontales, Jinotega, and Río Plants in Operation San Juan). The World Bank will cofinance (under In 2004, Nicaragua's 104 MW of installed CNE loan) up to three hydro projects in the PERZA hydropower capacity generated an average of program and up to three hydro plants in the PCH 364 GWh per year. That year, hydropower program. In 2005, CNE succeeded in getting accounted for 11 percent of the national power Nicaragua's first public-private mini hydro project generation. Installed capacity included two large implemented. Known as El Bote, this 0.9 MW plant hydro plants, three mini plants and one is located in Nicaragua's central highlands. The micro plant: project is supported by the World Bank (PERZA program) and Swiss Agency for Development and · Large. Central America Hydropower Plant Cooperation, at a cost of US$2.7 million. El Bote (PCA), built in 1965 at Río Tuma and Santa delivers power to 2,700 rural residents, who Barbara Plant (PSB), built in 1972 at Río Viejo, consume 25 percent of the energy generated; the each has a nominal generating capacity of other 75 percent is sold to the national grid. To 50 MW; date, 48 km of transmission lines have been built. · Mini. Wabule (Wabule River) and Las Canoas The Nicaraguan government views El Bote (Malacatoya River), installed in 1989, each has as the start of a US$200 million project a capacity of 1.5 MW feeding into the national expected to develop 130 MW of RE-based grid (SIN); San José de Bocay, built in 1991, generation. In all, 10 small hydro stations has a capacity of 230 kW; and (ranging from 300 to 900 kW in size) are planned · Micro. La Chata, constructed in 1985, has a for construction. 100 kW capacity and supplies electricity to the rural population of El Cuá. Hydropower projects larger than 5 MW must await approval of the new Water Rights Law before they Projects under Consideration can begin development. Because of problems associated with adoption of Projects in the 5-25 MW segment could attract the new Water Rights Law (still pending), consortia of national investors. Two projects ­ hydropower activities since 2000 have focused Larreynaga (17 MW) and Pantasma (24 MW) ­ 26 Resource Potential and Exploitation Status have attracted investor interest, which CNE should 20-40 MW wind farms, after having implemented actively pursue. wind measurement programs on their respective project sites and having secured backing from The segment above 25 MW comprises foreign finance sources. The wind measurements 13 projects suggested by the International Finance were cofinanced by potential turbine suppliers. Corporation (IFC) (of the World Bank Group). Since the production cost per kWh of a 2004 wind Four of these ­ El Carmen (100 MW), Piedra Fina farm was higher than the average spot market price, the option of investing in a merchant plant (42 MW), Corriente Lira (40 MW) and Valentín project, selling directly into the spot market, was (28 MW) ­ are planned for implementation in not commercially viable. Since 2000, developers 2003-04, in accordance with the Electricity Sector have tried unsuccessfully to negotiate a PPA with Indicative Program. CNE/INE and the distribution company, Union Fenosa. Progress depends on INE and Union Wind Farm Projects Fenosa organizing a tender for a 20-40 MW wind farm, as anticipated in the draft RE Promotion Law Since the late 90s, three to four local project (Generación Eléctrica con Fuentes Renovables) developers have each been prepared to invest in and policy document. 27 4. RE Policy and Regulatory Framework, 1998-2005 By the end of 2005, to what extent had against perceived attempts of encroachment by Nicaragua put in place a regulatory framework CNE. More recently, the strained relationship providing clear long-term goals for RE policy? between President Bolaños, elected in 2002, and To what extent had the government addressed the National Assembly, has increased the difficulty the legal issues involved in natural resource of passing new laws.33 This situation has forced exploitation? Did power market rules treat RE CNE into over-reliance on presidential decrees for generators fairly? Were RE investors provided implementing laws and a piecemeal approach to access to internationally competitive project RE legislation. financing? By exploring these and other related questions, this Chapter seeks to identify During the 1998-2005 period,34 Nicaragua did Nicaragua's building blocks for success, not adopt formal policy targets for RE penetration pinpoint critical policy gaps and suggest in the national power market. The key framework initiatives that can boost RE investor confidence. laws and regulations for the power sector, Electricity Industry Law (Ley de la Industria Political Context and Policy Targets Eléctrica) (No. 272-1998) (Reglamento a la Ley de la Industria Electrica) and Electricity Industry In 1998, CNE, Nicaragua's lead institution for Law Regulation (Decree No. 42-1998), contain no formulating energy policy, faced formidable references to the promotion of RE and its political obstacles to putting in place a coherent RE integration into the power market. Rather, they policy.32 Many politically influential individuals saw reflect a blind faith in the ability of market no need for special RE legislation since the 1998 arrangements implemented by the acts to produce power sector reform had supposedly created a economically desirable results in the power sector. freely competitive regime for power generation investments. Adoption of basic laws permitting the The primary Renewable Energy Promotion Law exploitation of water and geothermal resources for (Ley para la Promoción de Generación Eléctrica energy purposes was beyond CNE's scope. con Fuentes Renovables) (No. 532-2005) Moreover, it faced problems of institutional rivalry declares that RE-based power generation is of with INE, which defended its dwindling jurisdiction national interest, states that RE should be given 32CNE was created by the 1998 Electricity Act. 33For example, Law No 511-2006, creating the Public Utility Superintendency as the regulatory authority for telecommunications, energy, water and sewage (eliminating sector regulators TELCOR, INE, and INAA) was not implemented. President Bolaños rejected the law's legality, not because he disagreed with its value but because of the National Assembly's appointment of the superintendent and four commissioners. 34Despite RE's share having gradually eroded on the national power market since 1980. 29 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua priority when contracting new generation, and resource exploitation);35 confirms the economic incentives introduced · Civil Code. Affects, inter alia, rights to water previously by presidential decrees; however, it resource management; provides no quantified RE targets. Similarly, the · Geothermal Resource Exploration and most important secondary law for RE, National Development Law (Ley de Exploración y Energy Policy (Decree No. 13-2004) (De Explotación de Recursos Geotérmicos) Establecimiento de la Política Energética (No. 443-2002), replaces geothermal Nacional),confirms RE's importance and regulations established under the General Law introduces economic incentives, but offers no on Natural Resources Exploitation; quantified goals. · Water Rights Law (in draft bill stage), replaces water regulations established It is at the level of implementing regulations ­ under the General Law on Natural CNE's Strategic Electricity Plan (2003) and Resources Exploitation; Electricity Sector Indicative Generation Plan · Forestry Law (Ley Forestal) (No. 462-2003), (2003-14) ­ that quantified targets first appear. establishes the regulatory framework for forest The Indicative Generation Plan includes one resource protection and sustainable 66 MW geothermal project and one 20 MW wind development (for dendro energy resources, farm in the short term (2004-06) and 561 MW of regulations cover secondary forest medium- and large-sized hydropower plants in the management, energy plantation promotion and medium and long term (2007-14). Yet, the targets transformation of forest and agricultural by- in these plans have no binding force, being products and waste); and indicative only. · Environment and Natural Resources Law (Ley General del Medio Ambiente y los Thus, except for the policy drive of CNE, Recursos Naturales) (No. 217-1996), Nicaragua's political attention to RE remained stipulates that environmental impact surprisingly passive at the end of 2005 ­ this assessments (EIAs) be prepared for power despite RE's impressive potential, its generation projects above 5 MW and cost-effectiveness in Nicaragua and the transmission projects above 69 kV (Ministry macroeconomic benefits of RE investment. of Environment and National Resources ­ Resource Management Laws MARENA is the regulatory authority). and Regulations Geothermal Exploitation General Laws and Regulations The Geothermal Resource Development Nicaragua's general laws and regulations for Exploration and Ley de Exploración y Explotación resource management include (Annex 2): de Recursos Geotérmicos Law (No. 443-2002) and its regulations, by putting in place a logically · Political Constitution, Article 102. Designates coherent framework for assigning geothermal water and geothermal resources as national exploitation rights, provide developers a heritage (a State concession is required for concession regime for resource exploration and 35Wind farms, established mainly on private lands, utilize wind, which does not require a concession for exploitation. 30 RE Policy and Regulatory Framework, 1998-2005 development. Developers must obtain concessions land use. The Environment and Natural from the INE. The application includes basic Resources Law (Article 106) states that information on the developer's experience in "renewable and nonrenewable natural geothermal development, and project aims and resources found in legally protected areas will objectives. The concession is usually valid for not be subject to exploration and exploitation." three years (with available extensions, Geothermal development will, therefore, be depending on the agreement between INE severely impeded if the Nicaraguan and the developer). government enacts the protected areas regulation, which expands many existing nature Once commercial amounts of geothermal reserves and establishes new municipal and energy are proven within the designated national parks, whose boundaries will be geographical area, the developer can obtain an defined by all lands above 300 meters in exploitation concession within that area, gaining elevation. If the regulation is adopted, most the right to produce commercial volumes of prime geothermal development targets geothermal resources. After INE issues the would lie within lands with restricted exploitation concession, the developer can apply development use.36 The Nicaraguan for an electricity generation license, authorizing government must seriously consider the him or her to build, own and operate an effects of such sweeping proposals for electrical power plant and generate electricity protected area status; it should perhaps over the long term (usually up to 30 years). Once consider joint use lands as a way to address INE approves this license, the developer must pay the manifold uses sought (for example, the State a granting right fee equal to 0.1 percent Kenya's geothermal development); and of project assets and post a guarantee bond for · Licensing fees. INE application fees for 1 percent of the project's base assets, which electricity generation licenses are higher for RE remains in effect for one year after the scheduled projects than conventional ones because they completion of plant construction. are fixed according to the investment size Although an environmental study or plan is not rather than power capacity. required for issuing a geothermal concession, Water Resources Exploitation all work done on the concession, as well as drilling activities, requires that MARENA The legal basis for water concessions, approve all environmental impact applications suspended in 2002, is the subject of the Water and studies. Rights Bill Anteproyecto Ley del Uso de Agua- While Nicaragua's overall legal and regulatory 2003, which replaces water rights sections of regime for geothermal exploitation is the General Law on Natural Resources satisfactory, two critical observations should Exploitation.37 Adoption of the new Water Rights be noted: Law has been delayed by conflicts between stakeholders and public institutions that regulate · Land use. A significant obstacle facing water rights among various uses, including geothermal development in Nicaragua involves hydropower generation. 36Law No. 272 establishes electricity-industry activities as indispensable for national progress and of national interest. The Environment Law permits natural resource exploitation in national parks, where prime geothermal resources are located, provided it is done in accordance with an approved environmental management plan. In practice, however, these measures may not suffice. 37The Electricity Act of 1998 exempts hydropower plants below 1 MW from having to obtain water-use concessions. 31 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua Two major challenges are: do not favor concluding long-term PPAs;40 and 2) they pay no premium for protection against the · Potential investor risk in watershed areas risk of price volatility or future upward shifts in vulnerable to reduced natural flow. Under the contracted power prices. Water Rights Bill, authorities may suspend, revoke or modify valid hydropower concessions Union Fenosa's bid evaluation method for in areas of reduced natural flow (induced by medium-term PPA tenders does not adjust for climate change) to ensure fair and equal differences in the price risks of offers.41 For the resource distribution. Such action, in turn, may off-taker, diesel power generation bids carry economically harm hydropower project two risks: 1) price volatility; and 2) risk of performance and increase investor risk higher prices per kWh over the next 10-20 (particularly since water for human consumption years, compared to the previous 10-20 years. is a stated national priority). It addition, banks With regard to price volatility, from November may be less willing to finance such projects; and 2000 to June 2003, average power market prices varied between US$34 and 59 per MWh · Lack of clear definitions, inter-institutional for the spot market (averaging US$46.5 per coordination and transparency. The approval MWh) and US$60 and 71 per MWh for the process for hydropower projects is complex, bulk market. In terms of higher prices for requiring authorizations by multiple imported fuel oil and diesel, average monomial institutions.38 But respective authorities often prices (per kWh) over a three-year period were lack sufficient technical criteria to justify their US¢7.3 (2004), US¢8.8 (2005) and US¢9.6 decisions. Without clear definitions and (2006). This trend illustrates the risk of a long- transparent decision-making criteria (for term upward shift in international fuel prices, example, for ROR schemes), otherwise which most experts have come to accept. qualified proposals and applications may be rejected.39 Various methods are used to price risk differences for volatility. One approach uses the market price Power Market Rules of hedged fuel prices as fuel price in the financial- Bidding for Generation economic modeling of levelized power plant prices. If consumers and the government value Nicaragua's bulk power market rules are biased long-term price stability, a comparison of the against RE generation bidders in two ways: 1) they levelized cost of renewable to diesel/fuel oil-fired 38The Ministry of Development, Industry and Trade (MIFIC) is responsible for aspects related to water of use concessions. The Water Rights Bill created the Nicaraguan Water Resources Council (CNRH) as the planning entity for hydrological resources. Within the MIFIC, the Natural Resources Administration (DGRN) (via AdAguas) acts as the administering entity for hydrological resources in coordination with MARENA, Nicaraguan Institute of Territorial Studies (INETER) and Ministry of Agriculture and Forestry MAGFOR. 39CNE, however, managed to push through adoption of the Hydropower Promotion Law in 2003, which enables ROR hydropower plants up to 5 MW to obtain the necessary water rights from MIFIC. The 2005 Law Amending the Hydropower Promotion Law expands this option for plants up to 30 MW. 40RE generators need long-term PPAs because they face higher market risks than coal-gas, and- diesel-fired power plants. They have a higher upfront investment per future kWh output and less protection against the effect of lower prices on the spot market because of low variable costs of operation. For a thermal power plant, less revenue from a lower spot market price is offset by lower operating costs, whereas the net revenue of an RE generator is hit fully: the highs and lows of spot prices are usually caused by variations in the prices of imported fuels for generation, except on markets with a high share of hydropower generation, where they can be caused by filled reservoirs due to heavy rainfall; yet, even in that case, the diesel power plant, being outpriced, saves its variable costs of generation. The positive side of price uncertainty is that RE generators benefit fully from higher-than-expected, spot market prices. Yet, even if that risk reward is sufficiently attractive for an equity investor, lenders usually base their decisions on conservative estimates of future uncertain revenues and, on top of that, request a risk premium. Thus, the ability of RE-based generation projects to reach financial closure depends on their capacity to show a signed long-term PPA with a fixed tariff. 41The "externality" problem in this case is that the price volatility hits consumers, the national economy and RE generators (due to higher net revenue uncertainty) but has little effect on diesel generators as long as price volatility is caused by variations in the price of imported fuels. 32 RE Policy and Regulatory Framework, 1998-2005 generation should be based on a hedged fuel reduced volatility and can include the value of price input, rather than an uncertain fuel price the protection against long-term shifts in the forecast. Instead of relying primarily on uncertain, average fuel price. long-term forecasts of spot prices for imported fuels, CNE power planners (and Union Fenosa What the 2000-2006 experience bears out is that under INE regulations) can use prices that are the costs of risk from uncertainty are real. With the locked in through futures; swaps; or fixed price, benefit of hindsight, any observer can see that physical supply contracts ("forward prices"). A US concluding long-term PPAs with Union Fenosa study of the difference between spot and forward would have resulted in lower average power prices (premium for price stability) of natural tariffs, at least during this period, and reduced gas contracts ranges from US¢0.05 to US¢0.08 price volatility. per million British thermal unit (MMBTU) Intermittent Supply Rules (Bolinger, Wiser and Golove, 2004). Assuming a highly efficient, gas-fired power plant, this adds Given that wind energy is an intermittent US¢0.04 to US¢0.06 per kWh to the levelized source of power supply, the entry of wind cost of the power plant. farms on Nicaragua's bulk power market has several implications. Another approach to modeling the cost of price volatility ­ or, conversely, the value of reduced Underestimated Capacity Value price volatility ­ is to apply the modern portfolio theory,42 making use of the capital asset pricing First, according to Nicaragua's market rules, an model (CAPM) to derive discount factors for intermittent supply source is not entitled to a various levels of uncertainty (Awerbuch and capacity payment in either the contracts market or Berger, 2003). Using lower discount factors for short-term capacity market, which is settled daily. uncertain fuel costs increases their net present For wind farm developers, the relevant value (NPV) and, thus the cost of production benchmark for comparing wind energy's price (per kWh) of plants using these fuels. This competitiveness is the spot market price.43 The approach assumes that a portfolio of assets is market rule underestimates the capacity value of the best way to hedge possible future outcomes wind farms.44 A power system must have sufficient to handle uncertainty. From this position, it reserve capacity to cover the demand for peak follows that conventional and RE sources are power when units are hit by unscheduled best evaluated not on the basis of their stand- production stops. The wind farm capacity to alone cost, but on that of their portfolio cost reduce investments in thermal power capacity, (that is, their cost contribution relative to their while keeping the loss of load probability constant, risk contribution to a portfolio of generating is debatable. Because the de facto power output of assets). The numerical results from such installed wind farm capacity depends on wind, it is simulations yield even higher value estimates of not firm capacity like thermal power. Wind farm 42Modern portfolio theory (sometimes referred to as mean-variance analysis) emphasizes that risk is an inherent part of higher reward. It shows how rational risk-averse investors use diversification to optimize their portfolio, and how an asset should be priced, given its risk relative to the market as a whole. According to the theory, it is possible to construct an "efficient frontier" of optimal portfolios offering the maximum possible expected return for a given level of risk. 43In 2000-2003, the spot market price averaged US$2 lower per kWh than the monomial price. 44The term capacity value refers to the savings in investment in new conventional power generation capacity made possible by the availability of wind farm capacity. Wind power's load-carrying capability is expressed as a percentage of the rated megawatt capacity of the wind farm. 33 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua output can be zero at any time, a fact that has led requirement of 5 percent of installed capacity few power system planners to conclude that wind reserve presents wind farms a greater farms have no effect on investment in thermal financial burden. power capacity; but this view is simplistic. An optimized power expansion plan aims at the level Seeking Rational Penetration Targets of capacity, which provides the system the optimal Third, the cost of intermittent power supply to the loss of load probability or load expectation. national operating system increases with the size of Probability analysis is multiplicative, not additive: wind power penetration of the national power what is the probability that the large thermal unit market. The need to contract thermal spinning shuts down on that rare day of peak consumption reserves and other regulating power increases. when all wind farms are not producing? Finding the maximum, economically rational Sophisticated power system simulation models can penetration target is a challenge. It makes little estimate thermal power investment needs for economic sense for installed wind farm capacity to cases with and without wind farm production. be larger than off-peak demand (that is, excess Simulations show that the capacity value for low supply from peak production during those periods levels of wind farm penetration is roughly equal to would be dumped). A recent CNE-supported study the wind farm's capacity factor45,46 but that it falls recommended installing no more than 50-60 MW rapidly at higher levels.47 The country's market of wind farm capacity during the next few years; rules, therefore, fail to pay wind farms the full after the first tender for 20-40 MW of capacity and value of their supply to the power system.48 before authorizing each new wind farm project, it recommended that CNDC conduct a detailed study Low Capacity Factor to establish the effect of additional capacity on the Second, wind farms have a lower capacity factor transmission system and the power market's than thermal power plants. Therefore, the absorption capacity (Jiménez and Povedano, 2003). Figure4.1:CNEOptionsforIntermittentPowerAccess Guaranteeing Market Access to Intermittent RE Generation Guarantee power pool Impose long-term PPA on long-term priority access at distribution company as public Impose RPS on retailers fixed PPA tariff service obligation 45The capacity factor is equal to the ratio of average to rated power of the wind farm (equal to the annual delivered MWh to the grid, divided by the installed megawatt times 8,760). 46Since capacity-credit results depend heavily on what happens during the utility's peak hour(s), most calculations determine the average capacity factor for the upper 10-30 percent of hourly peak loads. Some refine the analysis by calculating the capacity factor for the hours during which the risk of not meeting the load is highest. 47In Ireland, simulations based on an annual capacity factor for wind energy (up to at least 800 MW) resulted in a capacity-credit of about 20 percent. An early paper on the Electricity Supply Board (ESB) system determined a capacity-credit of 35 percent of wind capacity for the first few MW (that is, approximating the annual capacity factor), falling to 14 percent for 2,000 MW and 11 percent for 3,000 MW; see Commission for Energy Regulation/OFREG NI, p. 40 (2003). 48In the United States, standard market-design rules proposed by the Federal Energy Regulatory Commission allow wind farms to participate in the capacity market. For example, PJM Interconnections allows wind generators to claim and sell capacity credits within its six-State operating area, providing wind generators revenue of about US¢0.01 per kWh. Capacity value is based on a three-year rolling average of a wind farm's performance during PJM's peak hours. 34 RE Policy and Regulatory Framework, 1998-2005 Intermittent power supply also affects micro and opted to provide intermittent suppliers long-term small hydropower output. Plants of up to 50 MW priority access to the power pool at a fixed PPA tariff. capacity are ROR, without seasonal storage capacity (any storage is for regulating daily peak Under Presidential Decree 12-2004, wind farm load). Thus, in the case of hydropower, intermittent and ROR hydropower projects (installed within six supply is seasonal (after the rainy season, for years of promulgating the decree) are guaranteed example, supply may drop to zero during all or priority access to the power market at a fixed tariff part of certain days). per kWh, valid for 12 years from start-up of operations50 (tariffs are US$5.5-6.5).51 CNDC CNE's Challenge administers the market arrangement, paying the hydropower plants for their kilowatt-per-hour For CNE, the challenge posed by intermittent wind supply and charging electricity purchasers costs energy and small hydropower output has been to above the power pool price on a pro-rated basis, identify the ideal protected or mandated market in accordance with their market purchases. INE is arrangement. In theory, it could have chosen entrusted with the task of adopting the necessary among three alternatives (Figure 4.1). rules and regulations for implementing this policy (by resolution of the INE Advisory Council). Introducing a renewable portfolio standard (RPS), accompanied by green certificates for trading, made The scheme provides RE generators two no sense in the Nicaraguan context. The power benefits: 1) eliminating market risk (certainty of market is too small; furthermore, it is dominated by average kilowatt-per-hour tariff); and a monopsony buyer.49 Imposing on the distribution 2) reducing the payment risk for supplied company the public service obligation of holding a energy (compared to the alternative of long- tender for a specified amount of wind farm capacity term PPAs with Union Fenosa). For wind farms, and signing a long-term PPA with the least-cost the proposed procedure is as follows: bidder was feasible, but not ideal. First, selling intermittent supply to the spot market, where short- · Developers apply to INE/CNE. If more than term wind energy fluctuations can be treated as one developer expresses interest in setting up a negative demand, is more rational than selling 20 MW wind farm, CNE and INE will organize projected output through long-term PPAs with a final a tender for a 20 MW wind farm. The bidder off-taker. Second, it would lead to the question of requesting the lowest tariff gets a wind farm how surcosts arising from the PPA could be assigned generation license from INE, which defines the to industrial firms purchasing their power directly terms of the PPA ; from the bulk power market. Third, Union Fenosa's · ENTRESA (the State-owned national weak financial situation would lead banks to impose transmission company), through its CNDC, a risk premium on wind farm loans. Thus, CNE pays RE generators for their supply, and 49GPS (2006) recommends that Nicaragua develop a separate market by establishing a RPS of 30 percent in 2006 and 40 percent by 2013. Either CNE or Union Fenosa could be chartered the task of collecting/holding the RECs associated with new renewable generation. In turn, they would be expected to market the RECs to the highest bidder, with proceeds used to offset the higher cost of renewables in the Nicaraguan market. This recommendation, however, overlooks which market Union Fenosa should target (the five industrial firms with direct access to bulk power purchases are tiny and lack the liquidity for efficiency). 50DNE could have introduced the option of paying RE generators a fixed "green" premium (to be received on top of the spot market price). To preserve part of the fixed price advantage, the premium could have been subject to a limit on the total monthly average remuneration per kWh (for example, US$70 per MWh). Based on spot market prices from November 2000 to June 2003, an RE wind farm premium of US$10 per MWh would have resulted in an average revenue of US$56 per MWh. While the procedure would have brought payments to RE generators more in line with daily spot market prices, it would have increased the risk to RE generators and reduced the RE price stabilization effect. 51Originally, the maximum price for hydropower was US$5.9 per kWh. 35 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua charges any financial losses on it (that is, the connection cost, whether the pricing policy difference between the fixed PPA tariff and applied is "shallow" (covering direct cost only) the power pool prices) to off-takers from the or "deep" (also including the cost of grid power pool on a pro-rated basis, according reinforcement). In addition, they involve to their purchase levels; and transmission cost, which is fixed by a national · Developers can apply to set up additional "postage-stamp" tariff policy. For other issues, wind farms in future years. But project INE, in consultation with CNE, develops rules authorization requires, as part of the and regulations. proposal process, that they finance a system impact study that proves that the integrated Is a Mandated Market Needed? power system can economically absorb the wind farm. Mandated market instruments are rules imposed on the power market that give RE generators It remains unclear how future negotiations access to the market on preferential terms. between CNE/INE and project developers will Such instruments take many forms, the main occur. It is also left open how project developers distinctions being between feed-in tariffs, will finance system impact studies when tradable green certificates/RPS and periodic more than one investor is interested in a tenders for specified types of RE generation.52 follow-up license. Mandated market instruments are introduced to address specific weaknesses of RE generators Asking developers to pay for the study before that prevent them from competing efficiently in the project is tendered is unattractive to losing the market.53 An example is Presidential Decree bidders (unless the winning bidder covers their 12-2004, which gives intermittent wind farm costs). Since it is expected that more than one and small-scale hydro generators in Nicaragua developer will apply for a follow-up license, guaranteed market access (that is, they may it is more rational for CNDC to finance and bypass general rules for selling power to prepare the system impact study and recuperate the market). the cost from the winning bidder by asking him or her to cover the study cost as part of the Discriminatory pricing rules prevent RE license fee. generators from obtaining prices for their Grid Connection Rules and Prices output that reflect their value to consumers and the national economy. Eliminating such Grid connection rules encompass several rules from Nicaragua's power market should, elements. They involve the right of RE in principle, suffice for RE generators other generators to connect to the transmission system than wind farm and small-scale hydro to out- or distribution grid. They also cover the terms of compete diesel generators. 52See Annex 3 for a review of international experience with RE promotion schemes. 53Mandated market instruments were developed for countries where ­ unlike Nicaragua ­ the production costs of RE generators (other than medium- and large-scale hydropower) are not competitive with the supply prices of conventional power plants. These countries promote RE penetration in the power market in order to reap environmental benefits, improve security of supply caused by a reduction in imported fuels and reduce the production cost of future RE systems since creation of a larger market is expected to accelerate RE product development and productivity increases. In that context, the mandated market tool has the dual purpose of 1) creating a niche or start-up market for beneficiary RE generators, giving them a larger share than a purely commercial market would permit; and 2) financing the subsidy burden of increased RE penetration through higher electricity bills, thereby replacing the need for taxpayer-financed incentives. 36 RE Policy and Regulatory Framework, 1998-2005 Yet, the question remains: could Nicaragua benefit heat to the electricity plant. Under a tolling from mandating a minimum market for RE arrangement, the geothermal heat extraction generation, including geothermal and hydropower company provides steam to the power plant at no plants?54 The goal would not be to create a niche cost and accepts power generated from the plant market for RE generators; rather, it would be to against a conversion fee. In Nicaragua, the most transform RE generation into the country's likely scenario is that a single geothermal power dominant source of power supply. RE could be company would undertake both functions, holding broadly justified as the least-cost source of power both the concession and the license. supply, which could relieve investor uncertainty. The mandated market would be faster and more Because geothermal and hydropower projects cost-effective than investment incentives, which exploit a public resource on public land, the could be eliminated. question arises: what policy should Nicaragua pursue regarding ownership of a geothermal Standardized Administrative Procedures energy or hydropower plant when the concession and the license end after 20-30 years? The What Is Nicaragua's Concession Policy? transfer arrangement sure to create the highest Geothermal and hydropower projects are NPV for the State as resource owner is build, own, constructed on State-owned land. They are subject operate, transfer (BOOT), whereby the State to a dual authorization regime: a concession for becomes the plant owner at the end of the exploitation of the natural resource and a license concession period free of charge. In this case, it for power generation. must be decided at the project outset who the assets recipient will be at the end of the concession For hydropower plants and wind farms, resource and license period. The most logical candidate is exploitation and power generation functions are ENTRESA, the State-owned holding company. united in a single production unit;55 for geothermal energy, however, resource extraction and power At the time of transfer, ENTRESA has several generation are separate functions: hot water options. It could arrange for an extension with the extraction and steam production for power plant developer. Alternatively, it could sell the project to generation. This opens up the possibility that a a third party. An open auction to the highest geothermal exploration and development bidder, with both the original developer and company holding the concession for resource prospective third parties invited to bid, might exploitation would undertake heat extraction, while provide the highest value to the Nicaraguan a power company holding the license for government.56 A third option would be for producing electricity at the site would produce ENTRESA itself to operate the hydropower or electricity using the heat resource. Contractual geothermal power plant. In the case of a arrangements between the two parties can vary geothermal plant, ENTRESA would have a fourth (GPS 2006). The geothermal company can sell option: It could sign a management and operating 54The indicative expansion plan (IEP), prepared and published by CNE, identifies various RE projects as the least-cost option for new power generation capacity. Although the 1998 Electricity Act stipulates that investment in new power generation must consider CNE's IEP in practice, this regulation has proven too soft to serve as a mandated market tool for RE generation. It does not prevent potential investors in conventional power generation from tendering and winning bids for new PPAs, as long as INE is willing to issue generation licenses to new conventional thermal power plants. 55Except for multipurpose dams, which are constructed for irrigation and/or as storage reservoirs for potable water; small hydropower plants are attached to such dams. 56If that option is selected, GPS (2006) suggests that auction revenue would be in lieu of royalties during the initial contract period. 37 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua contract with the company handing over plant format; their formalization is a future area of high operation and undertake the power production public return. function. The Nicaraguan government must decide these transfer arrangement issues before a CNE and Union Fenosa could jointly establish a concession contract is signed. standardized contract program, which would periodically solicit power supply bids from Prefeasibility Study Licenses developers. Timing of the requests and the amount of capacity requested would be determined by a Power station and transmission facility projects planning process based on growth in peak-and using RE require that INE issue a temporary base-load demand. Economies of scale would be license for a maximum period of two years. The an important consideration in solicitation size. project developer must pay INE a fee equal to 0.1 Based on expected load growth, solicitations would percent of the total investment. The current law be made every two-to-five years for 50-100 MW. does not provide for an extension of the temporary The planning process would anticipate needs license. However, if resource data must be approximately five years ahead (the time required gathered, the two-year period is insufficient. The to develop a power plant). option of extending the license (up to five years for hydropower) should be introduced at the Allowing bids from planned geothermal power investor's request. plants to reserve the right to bid at defined points in the future would allow a developer to take Contracts and Bidding Procedures advantage of economies of scale and reduced risk through knowledge of the geothermal resource to An effective way to reduce transaction costs, provide a competitive bid. Similarly, this could investor uncertainty and time spent on project allow ENTRESA to build the expected incremental preparation and implementation is to prepare capacity into transmission lines, thereby realizing standard documents for most anticipated contracts. its own economies of scale. Important documents include (but are not limited to) the following: Standardized contracts would be completed within five years. For oversubscribed solicitations, CNE · Concession documents for the exploitation of and Union Fenosa would negotiate first with the hydropower and geothermal resources; bidder with the lowest offering price. Otherwise, · Contracts for BOOT or build-own-transfer pricing would be negotiated into standardized (BOT) arrangements; contracts or set in advance by them. · Grid connection contracts with ENTRESA and distribution companies; One-stop Shop for Developers · Contracts for transmission and power wheeling (for example, RE generator connected to a The Renewable Energy Promotion Bill of 2005 distribution grid); anticipated establishment of a one-stop · PPAs with Union Fenosa; clearinghouse (a function that CNE might perform), · Supply contracts with CNDC for which would serve as a focal contact for intermittent power; coordinating interventions by government institutions · Construction permits; and involved in RE project planning and approval. The · Formats for EIAs. clearinghouse would support developers in securing access to financing by expediting licenses and Several documents already exist in standard concessions, land acquisition and access to foreign format, while others are in table-of-contents technical assistance. Implementing this function 38 RE Policy and Regulatory Framework, 1998-2005 would require providing CNE an adequate down). In the area of government-financed financialbudget. resource surveys, Nicaragua has advanced far.57 Local Approval Regulations To encourage foreign investment, the Nicaraguan government ­ like governments throughout the Typically, weak local planning guidelines and developing world ­ must finance geothermal energy procedures for EIAs delay progress in project and large-scale hydropower projects based on long- implementation around the world. In Nicaragua, term PPAs with sovereign government guarantees.58 local responsibilities (as listed in the Municipalities Offering long-term PPAs, together with innovative Law [Article 7]) include issuing opinions on pricing structures, will permit higher returns in early contracts and concessions that aim to exploit years to pay down the large debt required for such natural resources in the municipality. Before it can projects, combined with lower pricing in later years. issue a license or concession, the issuing body The government has already adopted this approach must receive the opinions. While local authorities' for wind farms and hydropower plants of up to involvement in RE project approval is marginal, it 5 MW by introducing a 12-year PPA contracts must be tested, in practice, whether local land use (after this period, investors must rely solely on the regulations and construction permits pose free market). problems for project implementation. Incentives Regime Investment Incentives Government's Risk-sharing Role CNE has struggled to introduce economic incentives for RE investments through a variety of The Nicaraguan government has an essential role ad hoc laws, presidential decrees and regulations. to play in RE risk-sharing. It can accelerate the The most important of these have been the commercial development of geothermal energy Hydropower Promotion Law and Decree No. and hydropower by taking on high-risk 12-2004 (Supporting Wind Energy and ROR investments in upfront resource development. For Hydro). CNE recognizes that the piecemeal geothermal energy, this means investing in approach has not worked and that transparency geological and geophysical programs, heat-flow has been inadequate. Thus, it has amalgamated surveys and deep-exploration drilling to evaluate the incentives already adopted into the RE and promote resource areas. For hydropower, it Promotion Law, adopted by Parliament in late means investing in water-flow measurements and 200559 (the same fusion of incentives was prefeasibility studies. Ultimately, private investors undertaken a year earlier via Presidential Decree who take on the subsequent development of 13-2004 (Establishment of a National Energy commercially interesting sites must cover the cost Policy). The RE Promotion Law exempts new of this investment. Private investors could pay a projects (for a 15-year period from adoption of royalty after the first 10-15 years of operation, the law) from paying import duties and taxes and when project debt is paid off (or substantially paid value added tax (VAT) on equipment, materials 57 CNE, in close coordination with INETER, should decide on immediate steps to secure and improve river-flow measurements for high priority sites listed in the project investment guide. This may require that CNE acquire appropriate software for evaluating flow measurement data and conduct training in applying respective methods. 58 Financing projects with corporate guarantees from Union Fenosa is not feasible (Union Fenosa in Spain refuses to do so, and the distributor cannot provide lenders the creditworthiness they seek). 59 Ley para la Promoción de Generación Eléctrica con Fuentes Renovables. 39 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua and other accessories for isolated-system is limited to small-scale RE projects. Currently, generation, transmission and distribution. It also CNE has no specific policies in this area, but exempts these projects from paying income taxes one may expect flexibility if the need arises. (for a seven-year period after start-up of Payments for deep-connection costs are a commercial operation). No municipal taxes are separate issue, as they can determine the owed during construction and the 10-year period commercial viability of even mid-sized after start-up of commercial operations. No stamp RE plants. duties are owed for 10 years, and all taxes related to natural resource exploitation are waived. Project Finance Conditions on National In addition, wind energy and ROR hydropower Capital Market projects are not required to provide reserve and Nicaragua's local capital market is incapable of balancing capacity. providing long-term financing of investments in According to Jiménez and Povedano (2003), the geothermal energy and hydropower plants and combined value of these incentives amounts to wind farms. In addition to the high cost of finance, US$3 per MWh for wind farms, which is the country's banking sector is plagued by a generous. Yet, since nothing is wrong with the liquidity squeeze and bad loans in its portfolio; basic economic cost-competitiveness of RE both factors limit banks' ability to finance new generators, the incentives are somehow investments, particularly larger-scale ones.60 This misplaced, reflecting regulatory failure. situation, in turn, reduces local investors' ability to engage in RE projects, making the investment level Subsidized Infrastructure in Nicaragua too dependent on foreign perceptions about the country's investment Wind farm, hydropower and geothermal climate. In addition, it leads to a large part of the projects can provide new regional and local annual value, added from projects and foreign infrastructure in the form of access roads and exchange savings, being transferred abroad. In transmission lines. Access roads can benefit short, the local-capital-market barrier reflects a many local economic activities beyond the RE vicious cycle,61 justifying the case for assisted project. Transmission lines may make it market development. economically viable to expand grid service to previously unconnected rural communities or Despite the national capital market's scarcity of those served by isolated, diesel-powered grids. long-term financing on reasonably good terms, In such cases, cost-sharing of infrastructure large-scale RE investments have precisely that investments by private RE investors and public level of demand-side quality that can bring budgets may be justified. However, the forward a supply of good project financing. effectiveness of such subsidies in promoting new Financial assets that derive their income from RE RE projects depends on whether cost-sharing is projects and have long-term PPAs with reliable off- required to make marginal projects financially takers offer financial investors seeking long-term, viable for the private investor. Such a situation low-risk assets an ideal profile. 60By law and in light of their precarious balance sheets, Nicaraguan banks in the late 90s had to restrict individual lending to a maximum of US$1 million. In 1997, the nominal interest rate was 24 percent, while inflation was 9-10 percent. 61Nicaragua lacks a capable capital market because of insufficient demand from private industry and services and no demand from high quality, large-scale infrastructure projects for long-term local financing. But such projects seek financing from abroad for lack of a local capital market capable of providing long-term financing. 40 RE Policy and Regulatory Framework, 1998-2005 CNE and traditional collaborating development What Is Missing in Nicaragua's RE Policy? banks are aware of the situation and the benefits of introducing new forms of project Lessons from international experience suggest that finance and risk instruments on the national two factors are critical for RE policy success: market. But because of Nicaragua's difficult 1) a comprehensive regulatory framework;62 and financial and debt situation, these partners 2) government's adoption of published, quantified can provide only limited funds to targets for RE penetration into the power market by State institutions. specified years (Annex 3). This Chapter review shows that, by the end of 2005, Nicaragua's RE Support to Local Supply Industries and R&D policy and regulatory framework contained many of the relevant building blocks but lacked critical The past 20 years has witnessed the fundamentals: quantified targets for RE penetration, Nicaraguan government's gradual loss of adequate natural resource laws and appropriate motivation to actively engage in a support power rules for tendering new generation. program to build national research and development (R&D) and private consultancy, Beyond CNE's Policy Drive construction and developer expertise. One Faced with the difficulty of obtaining essential natural exception, however, has been decentralized resource and RE laws passed by Parliament, CNE rural electrification. In this area, the country has made use of presidential decrees and its power made great strides in building the expertise of planning instruments to get an RE policy in place. But NGOs, self-help organizations and presidential decrees cannot substitute for the long- communities. Even so, a recent hydropower term regulatory certainty of a law passed by study indicated that support was still needed in Parliament. Moreover, they cannot create such basic the following areas (Scheutzlich, 2004): elements as a Water Law. The RE Promotion Law of · Promoting the work of NGOs, cooperatives 2005 and earlier RE decrees and regulations offer and communities in mini hydropower project investors generous investment incentives. But development for rural electrification; failure to correct fundamental flaws in the power · Building local expertise in planning, sector regulatory framework render these incentives construction, operation and maintenance of powerless. Within its scope of influence, CNE complete mini hydro plants (up to 1 MW); accomplished what was feasible. But the RE · Initiating technology transfer of micro- and regulatory framework covers only the needs of mini-hydro turbine technology (mainly smaller power systems. Outside the donor-supported for Pelton and crossflow turbines), using area of small-scale RE for rural electrification, where projects have been implemented since 2000, proven designs; Nicaragua has little to boast. · Supporting local manufacture of pico- and micro-hydro turbines (up to 100 kW) Not surprisingly, Nicaragua's experience ­ including through workshops and craft centers; difficulty in getting parliamentary adoption of a · Promoting local manufacture of hydro- modern Water Law ­ is similar to that of other mechanical structures (for example, sluices, Central American countries who liberalized their valves, gates and penstocks); and power sectors in the 90s (Annex 3). These countries · Promoting local manufacture of posts and share an interest in designing rules for the regional electric accessories for the local, low-voltage power market that facilitate investment in RE-based distribution grid. generation in their countries (Box 4.1). 41 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua Box4.1:Postreform:ARegionalPerspective Power sector reform across Central America in the 90s was based on privatization, liberalization and market forces. All six countries had signed regional policy declarations favoring RE. Ironically, by the end of 2002, RE share in total power generation was only 59 percent, 32 percent lower than in 1990 (ECLAC, 2004). Costa Rica ­ the only country not to have privatized its State- and cooperative- owned power sector ­ saw its RE share in generation rise to 98 percent; it fell in all other countries, with Nicaragua at the bottom (23 percent). Private foreign investment went into oil-fired power plants and a single coal-fired plant. Major reasons were conventional energy's shorter gestation period and lower capital intensity, lack of clearly defined water rights and biased bulk-power-market rules. Like Nicaragua, El Salvador, Guatemala, Honduras and Panama faced difficulties implementing national legislation that could have transformed the reform process into a greater success. In hindsight, the backlash of poorly sequenced reforms proved costly (Walker and Benavides, 2003). Today, a decade after civil war and authoritarian rule, Central American countries have an opportunity to boost economic recovery through regional integration. Beyond 2005: Policy Wake-up Call power plants to price controls for fuels and power prices in the spot market. In addition, it By late 2005, Nicaragua's hitherto hesitant makes theft of electricity illegal, authorizes the policymakers could no longer ignore the previous government to take credits from the international year's mounting international prices of crude and financial market for investments in RE projects imported fuel oil. In response, the National and creates two energy funds: Fund for the Assembly adopted several laws: Development of Energy Investments and Energy Crisis Fund; · Energy Service Stability Act (No. 554-2005) · RenewableEnergyPromotionLaw(No.532-2005) (Ley de Estabilidad del Servicio de Energía LeyparalaPromocióndeGeneraciónEléctricacon Eléctrica en el País). This law aims to reduce FuentesRenovables.BeyonddeclaringREtobeof the sociopolitical effect of rising transport and "ofnationalinterest,"thislawrequiresthe power prices. It introduces a series of short- distributioncompanytotender10-yearPPAswith term emergency measures to remain in effect REgenerators.Italsoprovidesgeneratorsselling as long as the price of crude oil remains above on-the-spotmarketmorefavorableterms(by US$50 per barrel and fossil fuels' share of confirmingtheUS$5.5-6.5perkWh);and power production is higher than 50 percent. It · Amendment to the Promotion Law for eliminates power sector import duties and taxes Hydropower (No. 531-2005) Ley de Reforma a la on fuels, keeps tariffs for up to 150 kWh per Ley 467 de Promoción al Subsector month at the early 2005 level,63 and introduces Hidroeléctrico. Adoption of this law authorizes the 62A comprehensive RE framework must comprise: 1) clear rules and regulations to enable RE generators to connect to the grid and sell the power market their output on acceptable terms; 2) financial incentives for investment and power sales; 3) clear procedures and guidelines for project planning and central-and-local project approval; and 4) access to project finance. 63Financed from the VAT revenue on power sales; distribution companies withhold the cost of required subsidies from their VAT payments to the treasury. 42 RE Policy and Regulatory Framework, 1998-2005 Ministry of Development, Industry and Trade rights (from 5 to 30 MW). On the other hand, (MIFIC) to grant ROR hydropower plants up to Law No. 532-2005, which echoes the economic 30 MW water rights after consultation with the incentives of earlier presidential decrees, lacks pertinent local authority. quantified RE targets. These laws, to a certain degree, build on CNE's As this Chapter demonstrates, breaking the earlier policy efforts. Law No. 554-2005 takes an barriers to investment in RE requires moving important step by declaring theft of power an beyond the status quo. Indeed, comprehensive illegal act. Law No. 531-2005 expands on the and coherent policy initiatives and strategies are Hydropower Promotion Law (No. 467-2003) (Ley required to correct fundamental flaws. de Promoción al Subsector Hidroeléctrico) by The next Chapter's recommendations seek to fill increasing the plant size limit for granting water this policy gap. 43 5. Breaking the Cycle: Renewable Energy (RE) Policies and Strategies To move towards a more virtuous circle of RE regulatory and incentive measures to eliminate investment, the Nicaraguan government must market-distorting barriers. initiate a comprehensive and coherent set of Fixing RE penetration targets is a vital tool for policies and strategies that unlock the country's RE building investor confidence, rallying political potential and, at the same time, reduce political support for adoption of the new RE and water laws and regulatory risk for investors. To this end, two and changes to the National Park Law, and major policy initiatives are required: maintaining the long-term momentum of national RE policy. Quantified targets can enable · Elimination of the fundamental, legal and Parliament and the Nicaraguan people to hold regulatory obstacles to investment in medium- their government accountable for progress and large-scale RE generation. For geothermal towards achieving the targets. energy, this implies making adjustments to the National Park Law; for hydropower, it means The proposed strategy for promoting RE investment adopting the new Water Rights Law; and in Nicaragua offers a comprehensive, cost-effective · Parliament's adoption of a RE law. This law sets approach to reducing demand- and supply-side minimum RE penetration targets in the national barriers to investment, improving access to project power market by 2010, 2015 and 2020; it finance and integrating RE promotion into the rural also provides a coherent set of policy, electrification policy (Figure 5.1). Figure5.1:ProposedStrategyforPromotingREInvestments Increasing Investor Improving Confidence Access to (Demand-side Project Conditions) Finance Strategy to Promote IPP Investments in Merchant Renewable Plant Energy Integrating Reducing Renewable Investor Risk Energy into (Supply-side Rural Conditions) Electrification 45 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua The strategy's four modules highlight two key and partial risk guarantees and political risk terms: comprehensiveness and risk management. insurance for RE investments in Nicaragua. RE experience in Nicaragua and around the world has underscored the lesson that comprehensive ­ Increasing Investor Confidence not partial ­ approaches are more effective at On the demand-side, the strategy must respond to unlocking a country's RE potential. The strategy four off-take risks for RE generators. First, as aims, above all, to eliminate investor risk of mentioned in previous sections, Nicaragua's political and regulatory uncertainty.64 In power market is small, dominated by only one off- Nicaragua, reducing risk and uncertainty provides taker. Second, annual growth in power demand is investors a stronger signal and is more cost- relatively low. Third, Union Fenosa, the major off- effective than investment incentives.65 Indeed, taker, represents a payment risk because of its investment incentives are a minor complementary large technical and nontechnical losses, which and, in the end, dispensable part of the RE undermine the distributor's financial balance. strategy: under the right regulatory conditions, Finally, in the absence of risk analysis and criteria, RE investments in Nicaragua are fully the country's tariff evaluation method in tenders competitive with thermal power projects. Next in for new generation is skewed towards thermal importance are measures to reduce market risks power. The proposed strategy's four for RE generators. recommendations, discussed below, aim at The RE risk mitigation policy, which cuts across the reducing off-take risk for RE generation. strategy's four modules, has five pillars: Reduce Off-take Risk of Sales to Union Fenosa Creation of a legal and institutional environment Assist Union Fenosa in Reducing Distribution Losses for the power industry in which project developers face minimal regulatory, off-take and shifts-in- Issue. Union Fenosa's inability to resolve its policy risks. problem of high system losses and low bill collection rates is caused, in part, by several · Promotion of the Central American power interrelated factors beyond the company's market to provide economies of scale for new RE control. These are: 1) a culture of theft among investments and dismantle the monopsonistic a minority of consumers; 2) absence of laws structure of the bulk power market; making electricity theft a criminal offense; and · Public investment in data collection on RE 3) absence of court capacity allowing a resources in Nicaragua and cost estimates for distribution company to take repeat offenders their project development made publicly to court. available to investors; · Public risk-sharing of upfront investments in RE Recommendation. CNE, INE and the justice project development; and system should work with Union Fenosa in a · Involvement of multilateral and bilateral collaborative spirit to find solutions that reduce the development banks in providing credit lines distribution company's losses and restore its 64Traditionally, the literature distinguishes between the terms risk and uncertainty as follows: risk is subject to empirical measurement (described by the fluctuations around the average of a probability calculus), while uncertainty is nonquantifiable (the fluctuations of a variable cannot be described by a probability calculus). 65Project risk and uncertainty deter investments by increasing the cost of capital and hence the price of power from new projects. High risks lead to absence of investment if the risk premium makes a project commercially nonviable or project risk surpasses the risk limit of investors and lenders. 46 Breaking the Cycle: RE Policies and Strategies financial viability.66 The Energy Service Stability financial value per kWh of fixed price contracts. Act of 2005 (Ley de Estabilidad del Servicio de Evaluation of bids would be based on shadow Energía Eléctrica en el País)67 which declared theft prices for power, which add the quantified value of power ­ illegal connection, sale to a third party of price stability to the price per kWh of and meter alteration ­ an illegal act, was an generators linking their bid tariff to developments important step.68 A supplementary step forward in a fuel price index. This will lead to a more would be to introduce a small case court for the objective comparison of offers, giving renewable rapid prosecution of repeat offenders.69 generators a fairer chance to compete. To date, Nicaraguan legislation has not introduced this Use Risk- and Benefit-adjusted Prices in Tenders for adjustment. But the adjustment to the RE New Generation Promotion Act improves RE power's competitiveness by insisting that the price of tariff Issue. The 1998 Electricity Act requires that, at bids from conventional generators include duties the start of each year, Union Fenosa have PPAs and taxes in its calculation. covering a minimum of 80 percent of forecast power demand for the year and a minimum of Introduce Power Brokers in the Bulk Market 60 percent of forecast demand for the following year. The PPAs must be secured through Issue. Power brokers are market integrators; competitive bidding. Currently, the bid tariffs for they broker the relationship between generators new generation are compared without adjusting and large consumers by signing power supply for the objective financial value of long-term fixed contracts with the former and power sales prices versus bids that link the offered tariff to contracts with the latter. Even if power brokers development in the prices of imported fuels. Nor do not sign 10-15 year PPAs with RE projects, are the macroeconomic benefits of higher they reduce the off-take risk for generators domestic employment effects and foreign by providing a free market for one to three exchange savings taken into account.70 year contracts. Recommendation. CNE, INE and the Public Recommendation. To make the free market for Utility Superintendency should adjust the tender bulk power more efficient, consumer transaction evaluation method to include the risk value of bids costs should be reduced when purchasing power offering fixed tariffs for one-, five-, 10- and from suppliers other than Union Fenosa, and the 15-year supply contracts. A study (drawing, inter size of the free contract market should be alia, on results of financial portfolio theory and the expanded, the Nicaraguan government should CAPM) could be conducted to develop an encourage power brokers to enter the objective method for quantifying the economic- bulk market. 66The instrument for reducing widespread theft raises the cost of theft to offenders: the probability of being detected, multiplied by the sum of reconnection costs and the penalty incurred by detection. Union Fenosa, through its commercial-loss-reduction initiatives, can increase the risk of theft detection and, through the systematic removal of installations, increase the cost of reconnection; but only the State can raise the penalty. 67This law introduced State-financed tariff subsidies for those consuming less than 150 kWh per month to mitigate the effect of high fuel prices on average power tariffs. 68The act reduced Union Fenosa's accepted level of distribution losses from 15 percent in 2005 to 14 percent in 2006, with a further 1 percent reduction in subsequent years. 69Bringing repeat offenders to the traditional court system is too expensive for Union Fenosa. 70While this is not an issue for industrial countries with high employment rates, creation of domestic value-add is an important policy objective for countries with high levels of underemployment. 47 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua Power brokers should be able to enter the power · CNDC administers the market, pays market as independent brokers and dealers, generators for supplied power and charges provided they register with INE and CNDC as participants in the pool market surplus costs market participants. Yet, because the Electricity Act compared to spot market prices in proportion does not mention the power-broker concept, a to their electricity purchases; legal problem may need to be resolved · The tariff range for the monomial price paid to (Annex 2).71 eligible wind farm and hydropower generators is set at US¢5.5-6.5 per kWh; and Use Appropriate Mandated Market Instruments · The tariff formula in the tender documents Issue. The mandated market instrument allows may translate the monomial price into the designated RE portion of the bulk power seasonal and daily peak and off-peak prices, market to bypass the free market scheme using maintaining the guaranteed price as a year- rules that allow RE to be sold under privileged round average. This arrangement favors conditions. Applied appropriately, mandated suppliers whose respective wind and water market instruments can build investor confidence resources most closely match the profile of in the RE market and trust in the effectiveness of peak demand or who can combine wind the regulatory and financing environment. energy with power from a new small hydro supply. It also brings prices more in line with Recommendations. In Nicaragua's case, two movement in spot market prices, which "hard" mandated market instruments are facilitates CNDC's ability to assign incremental appropriate: 1) a niche market for intermittent costs from intermittent supply contracts to power supply from wind energy and ROR hydro; individual market participants.73 and 2) a 10-year moratorium on the construction of conventional power plants in order to develop Regarding the supplementary option to impose a the mass RE market. 10-year moratorium (except for peak and balancing power purposes) on constructing Regarding the niche market for intermittent conventional power plants, exploitation of potential power, Presidential Decree 12-2004 offers geothermal and hydropower sites represents the priority access to the spot market at a guaranteed least-cost expansion path for power generation monomial price, valid for 12 years of operation, over the next 20 years. The moratorium would to an initial 20 MW of wind farm capacity and reduce the cost of power supply by eliminating ROR hydropower projects completed within six higher-cost conventional plants and reducing the years of promulgating the decree.72 risk of RE project investment. Recommendations for the spot market Law No. 532-2005 provides CNE and the arrangement (defined in Annexes to the Superintendency the legal tools to implement such generation license) include the following: a moratorium. This law declares RE of national 71Similarly, Guatemala's electricity law makes no reference to powerbrokers. 72Growth in national power demand and aging of diesel generators calls for bringing 30-60 MW of new power capacity on line within the next two years. Power projects in advanced stages of project preparation comprise the San Jacinto geothermal power plant, three to four wind farms and two ROR hydropower projects. Getting enough of these projects implemented to satisfy demand for new capacity calls for a contracting framework that: 1) is fast; 2) provides more negotiating security than bilaterally-negotiated PPAs; and 3) is tailored to the characteristics of projects that have ready investors. Decree No. 12-2004 fulfills these requirements. 73Minimizing the differences between hourly pool prices and tariffs paid to wind farm-generated electricity also complies with the condition set forth in the Electricity Industry Law (No. 272-1998) Ley de la Industria Eléctrica, which states that RE prices should deviate little from free market prices. 48 Breaking the Cycle: RE Policies and Strategies interest, confirms that RE is to be given priority in economic rents of developers who acquire the development of new generation projects and least-cost sites. authorizes CNE and the Superintendency to impose an RE-percentage requirement on Recommendation. Nicaragua, which is distribution company tenders for new capacity. well-positioned regionally in terms of the quality of Since the law does not place a fixed limit on the its RE resource base, must put in place a percentage requirement, it could be fixed at regulatory, planning and project approval regime 100 percent for new capacity.74 which is second to none in the region. Promote Regional Power Market Reducing Investor Risk Issues. When completed in 2008, SIEPAC, the Implementing these demand-side measures regional power market, will gain rapidly in will go a long way toward increasing investor importance, with RE-based generation providing confidence in the existence of a market for RE- the bulk of supply. CNE and INE collaboration with generated output. Yet, to increase the necessary Central American counterparts in developing competition in supply and reduce production SIEPAC's structure and market rules will expand cost per kWh of output from future RE the potential market for medium- and large-scale generation, the Nicaraguan government must RE generators, allowing them to sell their output act to improve supply-side conditions for through PPAs with several off-takers. The larger investment. The following six major areas of size of the Central American bulk power market supply-side interventions are recommended. will improve Nicaragua's RE investment climate, Adopt Regulations for Resource Exploitation mitigate market risk and enable large-scale power projects to be implemented in the country. Issue. Geothermal and water resources are considered national heritage, meaning that the In terms of coordinating power market rules, State assigns project developers resource the two critical issues are how all countries can exploitation rights. To reduce investor risk, the agree on: 1) rules that promote RE penetration assignment of rights and obligations in primary into the Central American market; and 2) limits legislation and concession contracts must be to the national economic incentives offered to done in a legally clear, ordered manner.75 The RE investors to avoid a "race to the bottom," as recommendation here aims to provide investors each country tries to attract foreign investment needed clarity and eliminate ambiguities.76 toward development of its own resources. In a competitive Central American power pool, As the Natural Resources Law failed to properly power tariffs will be defined by the marginal assign water rights unequivocally, the legal basis cost of power (that is, the cost of conventional for water concessions (except for hydropower power generation). Generous RE economic plants under 1 MW) was suspended in 2002. incentives, therefore, will not benefit consumers A first step toward correcting the situation was through lower tariffs, but simply increase the adoption of Law No. 467-2003 and its 74Mandated emphasis on RE and introducing a positive RE bias in tenders for new generation raise the issue of how sufficient competition can be introduced in such tenders. 75It should be noted that, in cases of conflict, primary law takes precedence over contract law. 76In the water-management field, the main challenge is equal and fair distribution of water resources in a given watershed area for which the natural decrease of water flow, caused by climate change, is the main risk. The new Water Rights Law addresses this issue by allowing authorities to suspend, revoke or modify valid concessions in cases-of-natural flow-reduction. The concession defines the compensation in such cases. 49 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua adjustment in late 2005 (No. 531-2005), which standard documents and checklists and authorize the MIFIC to grant water rights to ROR assigning institutions direct responsibility for projects up to 30 MW. processing of applications for approval and investor requests for information. Recommendation. The new Water Rights Law must be approved immediately. Until this law is CNE, jointly with INE, Nicaraguan Institute of adopted, investor interest in larger hydropower Territorial Studies (INETER), Ministry of Agriculture projects with storage capacity will remain blocked. and Forestry MAGFOR, MARENA, MIFIC and other ministries and institutions, will establish a Streamline Approval and Planning Procedures one-stop clearinghouse for foreign and domestic Agreed-on Actions investors interested in RE projects (Figure 5.2). Conduct Government Review. The government One person in CNE (and one substitute) will be of Nicaragua, in consultation with the investor nominated and trained as the focal contact for community, will have to review existing planning investors wishing to stay informed about rules and and approval procedures to identify areas for regulations and economic conditions for streamlining. investment in geothermal and hydropower projects. The CNE officer, who will have direct Establish a One-stop Clearinghouse. Multiple contact with nominated staff in the above- national, regional and local government mentioned ministries, will be personally institutions are involved in the granting of responsible for providing technical assistance to, authorizations, concessions and public hearings on coordinating with and monitoring the work of environmental impact, land use and water rights lower level institutions which at various stages, issues. Other organizations are involved in the become involved in the project preparation and granting of economic incentives and company implementation process. For example, the registrations. This process must be rationalized nominated ministry staff person, responsible for and streamlined through preparation of local governments, will assist local authorities Figure5.2:One-stopClearinghouseOrganization CNE Project Responsibility: Global Information and Monitoring MARENA INE MIFIC MAGFOR Decentralization Project Project Project Project Ministry Project Responsibility Responsibility Responsibility Responsibility Responsibility Environmental Exploration and Water Land and Municipalities Impact Exploitation Concessions, Water Use Assessment Concessions, Economic Generation Incentives Licenses Organization of Conditions of Company Water use Land Acquisition, Public Hearings Power Supply Registration Master Plan Road Construction Connection 50 Breaking the Cycle: RE Policies and Strategies in processing work related to land a standard grid connection contract that includes compensation, resettlement and approval of conditions stipulating the relationship with CNDC, road construction. the grid-operating authority. The generation license may include a clause that entitles investors During the exploratory phase of project investment, to compensation if changes in national laws modify the one-stop clearinghouse set-up serves as a the operating regime. consultative mechanism, whereby a potential investor introduced to the cross-institutional core Invest in Resource and Project Cost Information team, which would follow the project, gains confidence in the smooth processing of requests. Have CNE Conduct Resource Assessments and During project implementation, the group is held Prefeasibility Studies. Getting CNE to collect relevant data and conduct research on projects responsible for administrative clearing of obstacles and their locations can substantially reduce andpotentialmisunderstandings. investor uncertainty. Consider Regulation for Joint Land Use in The National Energy Policy (Decree No. 13-2004) National Parks. Basic obstacles to geothermal (De Establecimiento de la Política Energética development in Nicaragua are new national land Nacional) confirms CNE's central role as use laws and regulations that expand national undertaking prefeasibility and feasibility studies for parks to include all lands above 300 meters in projects identified in the Indicative Plan. The Fund elevation. Most prime geothermal development for the Development of Energy Investments, targets lie within restricted use areas. One possible established by the Energy Service Stability Act (Law solution for combining energy and environmental No. 554-2005) (Ley de Estabilidad del Servicio de goals is to introduce a regulation for joint use Energía Eléctrica en el País) provides CNE an lands. The Nicaraguan government will analyze independent source of funding for these activities, the experience of other countries, including reducing its dependence on donor grants. Study Kenya, who have adopted this approach. results will be fed into the Nicaraguan Energy Information System (Sistema de Streamline Preparation and Approval for Información Energética de Nicaragua ­ SIEN) Environmental Studies and Plans. While an and Documentation Center (Centro de environmental study or plan is not required for Documentación). Unclassified information will be issuance of a geothermal concession, for all made freely available via CNE's website. concession work and drilling activities, MARENA must approve environmental impact Promote Public Risk-sharing in applications and studies. CNE and INE will Geothermal Exploitation consult with MARENA on how to streamline the process if it should cause investors delays Issue. Geothermal project experience in or increase their transaction costs. Nicaragua shows that private investors consider drilling expenses a risk they are hesitant to take Develop Standard Contracts for Grid on.77 To accelerate much-needed investment in Connection,Transmission and Generation. this perceived high-risk sector, The Energy Service CNE/INE will collaborate with ENTRESA to develop Stability Act (Law No. 554-2005, Article 6) 77In geothermal energy, the key concerns are: 1) long lead times (for example, planning consents); 2) exploration risk (for example, unexpected temperature and flow rate); 3) drilling expense and associated risk (for example, blowout); and 4) critical component failures (for example, pump breakdowns). 51 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua (Ley de Estabilidad del Servicio de Energía Upfront Government Finance of Resource Electríca en el País) authorizes the Nicaraguan Development with Tenders for Concessions government to take loans from the international together with INE's License for Power capital market to invest in RE-based power Generation. Under this arrangement, the generation, opening up its direct involvement in government invests upfront in resource evaluation energy sector investment. and promotion (through geological and geophysical programs, heat flow surveys and deep Agreed-on Actions exploration drilling). It recuperates the cost from investors, who develop the geothermal resources CNE, in consultation with private investors and identified by the program. Winning bidders of bilateral and international donors, will investigate tenders for exploitation concessions for identified four public-private risk-sharing arrangements to commercial deposits are charged a fixed fee. determine which are the most cost-effective for accelerating private geothermal and hydropower Partial Risk Guarantees and Contingent investments. The extent of the government's Finance for Private Investment. Under this cofinancing of energy sector investments will scheme, private developers invest in exploration depend on how maximum gearing of private and development, while the government provides investment can be achieved within a defined time them risk guarantees and contingent financing. This instrument could be set up in Nicaragua or at frame and the government's ability to conclude the Central-American regional level;78 but its loan agreements. viability presupposes financing of a fund by a Tolling Arrangement. Using this instrument ­ the development bank or the GEF. The fund would have a partial-risk-guarantee window, partially highest level of government risk-sharing in ensuring investors against the short-term risk of geothermal energy ­ a government entity invests exploration or the long-term risk of a deposit with in the exploration and development of a lower-than-expected temperature, geothermal resource. Once the commercial higher-than-expected levels of mineralization or feasibility of resource exploitation is established, difficult reinjectivity. Otherwise, the investor would, the State entity invests in the geothermal extraction as part of the investment, have to establish a plant, while the national energy regulator issues a reserve account within the package of project tender for the electrification portion of the project. finance as a safeguard for lenders. In addition, it The tender can be for either a steam-purchase or might have a further investment financing window steam-to-electricity contract. In the former case, providing contingent project development grants the generator sells the electricity in the power and low-cost loans. market. In the latter case, the entity provides steam to the plant at no cost and accepts power Exploration Investment Write-off of 250 generated from the plant against a conversion fee. Percent. This arrangement would become Any resource rent is effectively appropriated by effective during the first three years of geothermal the State or electricity consumers in the form of plant operation. It would not reduce investor risk, lower power tariffs. but would offer investors a risk premium. 78The World Bank's Geothermal Energy Development Project covers Bulgaria, the Czech Republic, Hungary, Poland, Romania, Russia, and Slovakia; the GeoFund covers the geological risks of geothermal investments. 52 Breaking the Cycle: RE Policies and Strategies Next Steps be implemented, the country's market for RE technologies is sufficiently large to make it With the exception of the tolling arrangement, the economically feasible to construct a national know- above instruments can exist concurrently, giving how base. private investors freedom of choice. The 250 percent write-off can be introduced soon and be Recommendation. Using the Energy made available to drilling investors without taking Development Fund, the Nicaraguan government recourse to contingent finance. can, inter alia, assist national universities in establishing collaboration agreements with the CNE will seek to establish information and experience exchange with Guatemala, which University of Reykjavik and U.S. research is developing a geothermal exploration institutions in geothermal energy and encourage and development program under a UNDP/ national engineers and manufacturers to GEF project. investigate how a small country like Iceland succeeded in building a competitive supplier Install Appropriate Incentive Regime industry in geothermal exploration and development. In June 2006, for example, CNE Issue. Law No. 532-2005 installs an incentive signed a cooperation agreement with the package, previously announced in Decree No. government of Iceland to exchange technical 13-2004, granting investors exoneration from information of relevance to geothermal energy. import duties; VAT; municipal taxes on components, machinery and equipment; and Improving Access to Project Finance national and municipal taxes on temporary equipment imports. It also grants a seven-year tax Competition for new projects can be increased holiday from start-up of commercial operations, and the cost of production and bid prices per kWh exoneration from municipal taxes during reduced if private investors ­ both national and construction and reduced municipal tax payments foreign ­ gain access to national and regional during the first 10 years of operation (75 percent, sources of project finance. CNE will actively first three years; 50 percent, next five years; and explore whether it is possible to facilitate national 25 percent, last two years). In addition, it grants a investors' access to project finance on competitive five-year holiday on natural resource taxes, terms by introducing: 1) new sources of project exoneration from stamp duties and a holiday on all finance; and 2) new guarantee instruments in the taxes related specifically to natural resource national capital market. Because RE projects exploitation over the 10-year period. differ substantially in size, technology and cost per MW, financing options must be flexible. Recommendation. INE could fix the granting- CNE's strategy comprises initiatives in the seven right fee and guarantee bond, paid to INE upon areas discussed below. issuance of a generation license, on a per megawatt basis rather than the estimated amount Tap National Debt and Equity Capital: of investment. The latter arrangement imposes Bond Issues higher costs on capital-intensive renewable generators than on diesel generators. Issue/Recommendation. Nicaragua's long-term Strengthen National R&D and Supplier Base potential for investing in geothermal and hydropower plants and wind farms provides an Issue. Because of Nicaragua's wealth of RE opportunity to develop an incipient capital market. resources and the large RE investments waiting to Such projects are of high quality: they are capital- 53 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua intensive, large in scope and scale and have requirement for investor equity than long-term acceptable risk levels and profiles.79 CNE will bank loans. discuss with project developers, the financial sector and potential portfolio investors (for The fixed annual income for revenue bonds is example, military pension funds) potential based on the future net revenue generated by the financing instruments with longer maturities and power plant, and is secured by the plant's physical lower capital costs that could be introduced assets. A financial buffer, in the form of purpose- successfully in the national market. specific accounts established upon bond issuance, provides added security for payment ability. One option is to issue revenue bonds with 15-20 Certain accounts cover risks prior to commercial year maturities backed by the revenue stream of operation (if issuance occurs before construction); financed projects. In principle, bonds are ideally others safeguard the ability to pay fixed annual suited to finance geothermal and hydropower dividends in years with below average water or plants and wind farms, which can prove to the wind availability. financing community that they have long-term PPAs for most of their output. For potential At the outset of the project cycle, developers use investors (for example, pension funds, insurance their own equity and short-term bank loans to companies and private individuals), bonds issued finance development up to the point of for power companies represent low risk and construction. The initial construction investment relatively high returns. For project developers, is financed by a mix of short-term national bank the attraction is longer maturity and a lower loans and export and supplier credits. When Figure5.3:RevenueBondsandtheProjectFinanceCycle Project Preparation Equity Investment by (5 percent of investment cost) Commissioning Project Developer Export Credit and Physical Investment in Local Bank Loan (1-3 years) for Suppliers' Credits Renewable Power Plant until Civil and Electrical Commissioning Infrastructure Final Long-term Project Finance Repayment of Short-term Loans Revenue from Bond Issue Repayment of Short-term Loans 79The strength of the U.S. and U.K. capital markets was founded in the late 19th century when capital demand was heavy for large-scale private investment in infrastructure: canals, railways, ports, and electricity. In developing countries, State-owned companies typically obtain financing from either State-owned national development banks or bilateral or multilateral development banks. 54 Breaking the Cycle: RE Policies and Strategies construction begins, an investment bank, chosen decisively bring private investments forward. In this by the investor, prepares a revenue bond issue case, the issue is not resource-risk but the ability to to finance the investment. The investment bank pay risks linked to rural poverty. In marketing fee for the bond issue is about 6-7 percent of household photovoltaic (PV) systems, international project finance, partly because of the risk to the experience has demonstrated that the market takes bank in underwriting the bond issue (that is, the off as soon as loan finance is made available for bank commits to purchasing bonds not sold at a consumer purchases and PV dealer investment and specified date at a predefined price). Revenue working capital. Yet PV system dealers and from the bond issue is then used to cover all developers of rural electrification and small-scale RE creditors and any outstanding construction and projects with viable business proposals may have working capital (Figure 5.3). difficulty getting conventional loans because they Because Nicaragua currently has no bond cannot offer sufficient assets as collateral. market, an initial issue faces a lack of both depth and liquidity in the local capital market. One possible scheme for making PV systems Lack of depth (absence of similar financial accessible to more rural households which lack products in the market) makes it difficult for access to electricity is to triangulate risks among investors to price the issue; except for the Nicaraguan government, PV-system dealers alternative investments abroad, they have no and commercial banks that offer rural reference benchmarks with which to compare household and dealer credits. To this end, the the asking price for a bond issue. Lack of small firms loan guarantee (SFLG), a joint liquidity means it may take a bond seller several venture between the U.K. Department of Trade weeks to find a buyer. For an individual project, and Industry (DTI) and approved lenders, can the risk of launching a long-term bond issue on serve as a model for how commercial lending a small untested market is high: the resulting can be directed from banks to PV-system cost-of-capital risks are substantially higher than dealers and project developers who want to for a traditional bank loan. Thus, Nicaraguan expand. Administered by the small business banks may hesitate to underwrite a long-term bond issue or may lack the required service (SBS), a DTI agency, the SFLG scheme capital to do so. allows small businesses with workable proposals that lack security to borrow money from Agreed-on Action. CNE will discuss with approved lenders. potential donors how a risk-sharing arrangement for overcoming the initial market Using the rural electrification fund (REF) hurdle could be grant-financed. One possibility approach, a business development organization is is to use a contingent fund to cover the usually contracted to provide rural entrepreneurs underwriting risk and a performance-based technical assistance on a cost-shared basis. contract signed with an investment bank to Potential borrowers must present a viable business undertake the bond issue. If the bond issue fails plan for the investment. Loans are provided by and is withdrawn, the investment bank's risk is approved lenders, who make all commercial limited to the incentive part of its pay. borrowing decisions. Through the SFLG, the Introduce Partial Risk Guarantees and government provides the lender a guarantee for Contingent Finance 75 percent of the loan (up to a maximum loan of £30,000). The business pays the government an Issue. In the context of rural electrification, partial annual 2 percent premium on the outstanding risk guarantees and contingent finance can loan amount. 55 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua A second possible scheme is to have solar home local communities and sell the surplus power to the system (SHS) dealers reach collaborative national grid are most efficiently undertaken by risk-sharing agreements with local microfinance local businesses and communities. But they may institutions for SHS purchases. Under this face challenges in raising the needed capital, on arrangement, the bank agrees to accept solar competitive terms, to move the project into panels as collateral when providing loans to construction. The ideal, least-cost solution would purchase SHSs from a dealer. In cases of default on be a scheme that combines the respective loan repayment, the dealer agrees to take back the comparative advantages of local private panels, paying the bank the nonamortized portion of entrepreneurs in project development and larger the loan. The dealer can then sell the panels to power companies in project finance. another consumer, while the bank is responsible for taking down the panels. Under a potential lease-buy-back scheme, CNDC, the power system and market operator, would be Agreed-on Action. In connection with the the off-taker fed by mini-hydro plants into the preparatory work to establish FODIEN, national grid (Figure 5.4). Against a small CNE will analyze the need to provide administration fee, CNDC would on-sell the partial risk guarantees to consumer and acquired power passively into the power pool dealer credits. (as now done under Decree 12-2004). Local Analyze Feasibility of Mini-hydro developers would undertake all project Leasing Schemes preparation. After completing a feasibility study confirming the scheme's economic and financial Issue. Investments in preparing and developing viability, the developer would negotiate a lease- mini-hydro projects to supply previously unserved financing arrangement with CNDC for the mini- Figure5.4:OrganizationofMini-hydroLease-Buy-backScheme Equity capital for Bank Project Developer project preparation in form of project Owner and Operator of Financing of Project time and cash Micro- or Mini-Hydro Preparation and Part of Construction Mini Hydropower Supplier Credits Plant Part of Construction Lease purchase agreement for power plant (lease payment deducted Buys Power Plant upon from payments for Commissioning supplied power) Passively on-sells power from CNDC generator into power pool 56 Breaking the Cycle: RE Policies and Strategies hydro plant. To finance the plant, CNDC would, in Agreed-onAction.CNEwillanalyzewhetheritis agreement with CNE and INE, set up a subsidiary feasibleandmeaningfultodevelopalease-buy-back to lease-finance small-scale RE projects developed arrangement for mini-hydro plants, which would by independent power producers (IPPs), drawing resolvethecollateralproblemandreducecapitalcost. on funds from a long-term loan facility provided by a donor or development bank. After signing Use Subsovereign Guarantees for the lease-finance agreement, the project Community Investment developer would use a mix of own equity, supplier Recommendation. As an alternative to facilitating credits and a local bank loan to finance the cost of rural communities' investment in mini hydropower investment up to commissioning the installed plant. plants, subsovereign guarantees can be used to At commissioning, CNDC would purchase the enhance the creditworthiness of local communities physical plant from the developer against a willing to invest in and operate such plants. This 10-year, lease-buy-back contract. In principle, the option can enhance investments in plants not plant price would equal the debt finance used for connected to the national grid where the lease-buy- development and construction, but would be back option with CNDC is not applicable. In Mexico, within the maximum fixed amount in the lease for example, a developer secured loan financing for agreement, as the developer and the cofinancing a wind farm selling power to the local municipality bank would have to carry the risk of construction by arranging a partial payment guarantee through cost overrun. Thus, the leasing fee would equal the development bank BANOBRAS. If needed, this the amortization payments and other financing bank could enforce payment from the off-taker by costs, which the power company would incur on withholding funds it would otherwise channel into its loans from the development banks, plus a risk the municipality from federal and State sources. and administration fee for the power company. At Use Environmental Finance the end of the lease period, the plant would be returned to the developer against a nominal Recommendation. Using environmental finance, US$1 payment. The developer would use the mainly the clean development mechanism (CDM), sales revenue to repay debt for project can narrow the gap between the monomial price development and would operate the plant. When of conventional power and RE generators. paying the IPP the monthly payment for delivered The certified emission reductions (CER) payments and sold power into the pool, CNDC would deduct facilitate promotion of and investment in RE the lease fee from the amount due. technology. To avoid "additionality criterion" problems associated with a mandated market The lease-buy-back scheme eliminates the need scheme, CNE/INE may fix an upper cap on the tariff for collateral, reduces project lending risks, per kWh, which is so low that it makes projects provides long maturities and results in lower dependent on CER revenue commercially viable.80 capital costs than those of any alternative scheme, making the financing conditions of small biomass- The GEF offers another potential funding source fueled generators and mini-hydro projects more for high-priority projects. Nicaragua's high competitive with supply from conventional plants. barriers to potentially large-scale, commercially 80Otherwise, the RE plant could be considered part of the baseline, and the project rejected for CDM registration. 57 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua viable RE investments present an opportunity to acceptable since the off-takers are private identify cooperation projects that fall within the distribution companies, not State-owned framework and priorities of GEF's Operational power companies. Program 6 (promoting RE adoption by removing barriers and reducing implementation costs), as Recommendation. To protect against political risk they will contribute to meeting the strategic in Nicaragua, foreign investors can access priorities of CC-2 (increased access to local instruments of the World Bank and Multilateral sources of financing for RE and energy efficiency) Investment Guarantee Agency (MIGA). The World and CC-3 (power sector policy frameworks Bank offers a partial risk guarantee to cover debt- supportive of RE and energy efficiency). service defaults on private sector project loans caused by the government's failure to meet its Use Bank Credits contractual obligations.81 The major risk categories covered are: 1) breach of contract; 2) availability Recommendation. Using soft loans, multilateral and convertibility of foreign exchange; 3) changes and bilateral development banks can play an in law; and 4) expropriation and nationalization. essential supplementary role in cofinancing RE investments since they have a lower rate of return MIGA provides eligible foreign investors risk perspective than conventional banks. However, guarantees against certain noncommercial risks the Nicaraguan government's current borrowing ­ political risk insurance ­ for qualified capacity is limited by its international agreements investments in developing member countries. as a highly-indebted country. That a private, not a The Agency insures new cross-border government, company would access such loans investments originating in any member country makes no difference since development banks destined for any other member country. Types require a sovereign government guarantee for of foreign investments covered include equity, their loans. shareholder loans and shareholder loan Introduce Risk Guarantees for guaranties, provided the loans have a minimum Foreign Investments three-year maturity. Equity investments can be covered up to 90 percent, and debt up to Issue. CNE believes that Nicaragua's economic 95 percent; coverage is typically available for reform program and the strength of its democratic up to 15 years (20 in certain cases). MIGA may stability are now recognized by the international insure up to US$200 million. Pricing is community. It also believes that results of its RE determined on the basis of both country and strategy in such areas as legislation, regulation, project risk; the effective price varies, finance, and intensified regional cross-country depending on the type of investment and trading of electricity give investors a reasonable industry sector. The investor has the option to investment climate. In other developing regions of cancel a policy after three years; however, the world, geothermal energy projects have been MIGA may not cancel the coverage. financed on the basis of long-term PPAs backed by sovereign government guarantees. But in the Typically, coverage protects against the risks of Nicaraguan context, this approach is not transfer restriction, expropriation, war and civil 81As its name implies, a partial risk guarantee covers a portion of the financing for which it provides support. 58 Breaking the Cycle: RE Policies and Strategies disturbance and breach of contract. The World Alternatively, the level of debt in HIDROGESA Bank partial risk guarantee requires a counter- could be increased by making a company bond guarantee of the host government. MIGA does not issue. It will be investigated with the financing require a counter-guarantee, but requests host community whether the State can raise more country approval before issuing a guarantee. money for FODIEN via this route than by selling The World Bank only insures debt instruments, the company equity. while MIGA covers equity as well.82 Support DER as FODIEN Secretariat Integrating RE into Rural Electrification Issue/Recommendation. Although FODIEN's Micro- and mini-hydropower plants; small-scale, organizational structure is still under biomass-fired power plants; and solar PV systems investigation,83 a strong possibility is that the fund will be promoted effectively wherever they can will be set up independently, overseen by a board, reduce the cost of power supply in rural with DER mandated to serve exclusively as electrification projects, both on- and off-grid. secretariat (but formally continuing as a unit under CNE). This structure would eliminate CNE's Analyze Financing Options conflicting roles as policymaker and project implementer. Compared to setting up a separate Issue. CNE's initiatives to lower the cost and secretariat under FODIEN, this alternative would increase the supply of RE project finance will offer administrative and operational cost savings, benefit smaller projects in rural areas. Rural RE along with flexibility of employment for staff and projects, which expand local residents' access to continuity of knowledge transfer to FODIEN. electricity, will have access to special financing lines within the overall financing packages Support FODIEN's Subsidy Functions available for rural electrification. Issue. FODIEN's subsidy policy and cofinancing Recommendation. While donors will continue to modalities have not yet been decided, as CNE is play a key role in providing funds for rural awaiting recommendations of an ongoing study. electrification, additional financing must be Most likely, FODIEN will provide cofinancing generated within Nicaragua to accelerate the rate grants to investments in rural electrification of rural electrification. Currently, HIDROGESA projects, with the dual objective of helping project (owned by ENEL as portfolio steward until developers get needed finance in place and privatization) acts as generator of national rural making the cost of electricity supply affordable to electrification funds. Its operating surplus covers poor rural households. the financial deficit incurred by ENEL on isolated grids served by diesel generators, as well as Recommendation. The top-down, rural GECSA's deficit. If HIDROGESA is privatized, electrification approach of PLANERAC and PLANER financial support for rural electrification could be ­ identifying priority projects and scoring them maintained by placing revenue from the sale in a against predefined criteria ­ will continue. But FODIEN account to cofinance investments. FODIEN's potential subsidy-financing line for bottom 82Details are available at www.worldbank.org/html/fpd/guarantees/. 83CNE has contracted a strong team of consultants to propose an organizational structure for FODIEN (the team presented an excellent introductory report in June 2004). Thus, this section is premature and is included for the sake of completeness. 59 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua up proposals from communities and developers rents between the State, electricity consumers and should also be encouraged. Viable projects could private investors. access subsidies with fixed published rates (per connected consumer for distribution projects and per The generous tax incentives of the first seven- installed kilowatt capacity kW for RE generators). 10 years of operation, combined with the This would allow communities that believe they have conclusion of 10-year PPAs for their output, a viable electrification project with the subsidies assure private investors and their cofinancing offered take electrification into their own hands. banks that the cash flow will allow a rapid payback on loans and invested equity. While this Promote Stand-alone Systems in arrangement may provide projects the certainty Absence of Grid needed to secure financial closure, the question remains: what happens when the 10-year PPAs Issue/Recommendation. Grid-based expire? Will resource rents (low costs of electrification is the highest-quality approach to production) be transferred to the State via water electricity supply; therefore, consumers consider it and geothermal concession fees, to consumers the ultimate electricity service. Stand-alone power via efficient annual bidding arrangements for systems owned and operated by individual consumers are too noisy (for example, small new power or to investors in the form of gasoline and diesel gensets) or much weaker (for higher profits? example, PV systems) than grid-based service. In the worst-case scenario, RE generators would CNE's rural electrification strategy acknowledges sell most of their output directly to a Central that the SHS is not intended to substitute for grid- American power pool ­ whose prices are based electrification; rather, it plays a determined mainly by the marginal cost of supplementary role, offering consumers a power conventional power plants ­ without paying the supply option when grid-based electricity State resource rents. In such a case, the benefits of is unavailable. price stability and low prices from RE generators Final Observations would be lost. The tariffs paid to RE generators would vary according to the fuel costs of thermal The CNE and Ministry of Finance and Public power generation; and private investors would Credit (MHCP) must carefully investigate whether reap the economic rents, except for the small the incentive regime established strikes the right share returned to the State via the company tax. balance between providing investors an attractive Once such scenarios are modeled, appropriate environment in which to accelerate investments policy recommendations derived from them must and achieving the appropriate sharing of resource be formulated. 60 6. Concluding Remarks Nicaraguan policymakers' naïve belief in the More recent events suggest further easing of 1998-99 reforms ­ that a free power market, barriers to RE investment. In July 2006, CNE issued through competitive pressure, could generate the an open invitation to potentially interested parties to optimal generation mix ­ has evaporated. By submit requests to INE for generation licenses to 2005, the high cost of international prices of develop one or more of the 12 hydropower crude and imported oil on the Nicaraguan projects, ranging in size from 2 to 30 MW, for which economy could no longer be ignored. Growing prefeasibility studies had been conducted. The momentum for RE projects is likely to be invitation refers to Law No 532-2005, which proved unstoppable. declares RE of national interest and Law No 554- 2005, which underscores the urgency of including As discussed in Chapter 4, the National Assembly more RE in the national energy matrix. The invitation recently adopted several laws ­ Energy Services also refers to future issuance of water rights by the Stability Act (No 554-2005) (Ley de Estabilidad MIFIC. Several months earlier, INE had signed del Servicio de Energía Electríca en el País) geothermal exploration contracts with Enel and LaGeo to explore two areas of 100 km2 each, Renewable Energy Promotion Law for Hydropower located in Managua-Chiltepe and El Hoyo-Monte (No 532-2005) and Amendment to the Promotion Galán (Chapter 3). Finally, wind farm developers, Law (No 531-2005) ­ that build, to a certain keenly awaiting issuance of a public tender, stand degree, on earlier policy efforts by the CNE. ready to invest in the 20-40 MW category. Adoption of these laws reflects a lessening of the deep political divisions that have long haracterized In sum, the improving political environment sends Nicaragua's business and regulatory environment a clear message to potential investors: RE is in and and, in turn, damaged investor confidence. new diesel generation is out. Yet, despite the favorable situation, adoption of the proposed In terms of public governance, establishing the comprehensive package of measures discussed in Public Utility Superintendency as the regulatory Chapter 5 ­ needed to ensure solid progress ­ is authority can ease institutional tensions between unlikely in the near term. More likely, new the CNE and INE. It should also accelerate components, building on those already in place adoption of the country's new Water Rights Law, (Chapter 4), will be adopted through a learning- whose delayed passage has further fueled the by-doing process as practical problems arise perception of investor risk. during project preparation and implementation. 61 References Awerbuch, S., and M. Berger. 2003. "Energy Commission for Energy Regulation/Office for the Security and Diversity in the EU: A Mean- Regulation of Electricity and Gas (OFREG) (NI). variance Portfolio Analysis." IEA Report No. 2003. "The Impacts of Increased Levels of EET/2003/03. Paris: International Wind Penetration on the Electricity Systems of Energy Agency. the Republic of Ireland and Northern Ireland." Final Report. Barnes, Douglas F., and Daniel Waddle. 2004. "Power-sector Reform and the Rural Poor in DOE. 2003. "Regional Indicators: Central Central America." ESMAP (Energy Sector America. Washington, DC: National Energy Management Assistance Program) Report Information Agency, Department of Energy. 297/04. Washington, DC: The World Bank. Ferrey, Steven. 2003. Small Power Purchase Bolinger, M., R. Wiser, and W. Golove. 2004. Agreement Applications for Renewable Energy "Accounting for Fuel Price Risk when Development: Lessons from Five Asian Comparing Renewable to Gas-fired Countries. Washington, DC: The World Bank. Generation: The Role of Forward Natural Gas Prices." Lawrence Berkeley National GPS (Global Power Solutions). 2006. "Nicaragua: Laboratory. Available at http:// Policy Strategy for the Promotion of Renewable eetd.lbl.gov/EA/EMP/. Energy. Geothermal Energy Component." GPS Final Report. ESMAP (Energy Sector ECLAC. 2004. Estrategia para el Fomento de Management Assistance Program). las Fuentes Renovables de Energía en Washington, DC: The World Bank. América Central. Santiago: Economic Commission for Latin America and Jiménez, O., and A. Povedano. 2003. "Caso de the Caribbean. Estudio: Situacióon y Perspectiva de la Energía Eólica." National Energy Commission (CNE)/ Close, D. 1999. Nicaragua: The Chamorro Energy Sector Management Assistance Years. Boulder, CO: Lynne Program (ESMAP). Rienner Publishers. Milligan, Michael R. 2002. Modeling Utility-scale Close, D., and K. Deonandan, eds. 2004. Wind Power Plants Part 2: Capacity Credit. Undoing Democracy: The Politics of Electoral Golden, CO: National Renewable Caudillismo. Lanham, MD: Lexington Books. Energy Laboratory. 63 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua Miranda, R., and William Ratliff. 1993. The Civil Energy Commission (CNE)/Energy War in Nicaragua. New Brunswick, NJ: Sector Management Assistance Transaction Publishers. Program (ESMAP). National Energy Commission, Synex Consulting Walker, Ian, and Juan Benavides. 2003. Engineers, and Gerens. 2004. "Diseño de la "Honduras: The Road to Sustainable Reform." Estructuración y Operación del Fondo de In Keeping the Lights On: Power Sector Reform Desarrollo de la Industria Eléctrica Nacional." in Latin America, eds. Jaime Millán and Nils- Estado de la Electrificación Rural y del Henrik M. von der Fehr, 163­215. FODIEN, Report No. 1. Washington, DC: Inter-American Development Bank. Scheutzlich, Thomas M. 2004. "Situation and Perspective of Hydroelectric Generation The World Bank. 2004. "Nicaragua Country (100 kW-25 MW) in Nicaragua." National Brief." Available at www.worldbank.org. 64 Annex 1 RE Legal and Regulatory Framework Nicaragua`s key power sector framework laws ­ · Article 112. Confirms INE approval of CNE- Electricity Industry Law (No. 272-1998) (Ley de la formulated, final-consumer tariffs, giving CNE Industria Electrica) and Electricity Industry Law an opening to pass on RE surcharges to Regulation (Decree No. 42-1998) (Reglamento a consumers;and la Ley de la Industría Eléctrica) ­ contain no · Article 130. Exempts investments in machinery references to promoting or incorporating RE into and other power generation inputs from taxes the country`s power market. However, the and import duties for three years. Nicaraguan government can use certain articles to introduce instruments and measures that In addition, the country has put in place a promoteRE. comprehensive, but not yet coherent, framework of laws and regulations to facilitate Electricity Industry Law: RE-related Articles RE investment. These can be divided into three broad (and sometimes overlapping) categories: In Law No 272, RE-related Articles include: · Umbrella framework (including CNE's Strategic · Article 2. Requires CNE/INE to identify and use Power Plan [2003] and National Energy sound project evaluation and approval Policy [Presidential Decree 13-2004] methods; De Establecimiento de la Política · Article 3. Makes general reference to public Energética Nacional); utility "declarados;" · Article 24. Requires new power investors to · Natural resource management (geothermal take the CNE-formulated expansion plan into and hydropower); and account, giving CNE an instrument for steering · Economic investment incentives. the composition of upcoming generation projects toward RE; Umbrella Framework · Article 51 (8). Authorizes CNE, via INE, to impose a management function on CNDC to CNE strategic plans and reports that favor purchase RE from the spot market; RE include: · Article 68. Establishes INE procedure for granting temporary licenses to power and · Electricity Sector Generation Indicative Plan transmission stations. (INE is paid 0.1 percent (2003-14). Includes one 66 MW geothermal of the total investment; since power stations project and one 20 MW wind farm in the short using RE are more capital-intensive than term (2004-2006) and 561 MW of medium- conventional power plants, their fee per and large-sized hydropower plants in the kilowatt hour kWh is higher); medium and longer term (2007-14). 65 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua Successful implementation of this plan would · Calls for studies on establishing a bulk market substantially raise RE share in the national power broker and jointly proposes with power mix. Yet, development of RE-based the MIFIC a one-stop shop for foreign generation potential is influenced by: investors;and 1) competitiveness of potential Nicaraguan · In rural electrification, imposes National projects in the regional power market; and Rural Electrification Plan (PLANER) 2) availability of natural gas for regional preparation and calls for reforming power generation; National Electricity Development Fund · Strategic Power Plan (2003); and (FODIEN) statutes, making subsidy policies · Nicaragua Electricity Sector Indicative Report more transparent and promoting PV (2001). Predicted that 106 MW of systems in areas without access to grid- geothermal plant would come online in based supply. 2001­05 through rehabilitation of the Momotombo plant. Natural Resource Management CNE has also published in-depth studies on RE- RE-related laws and regulations in natural resource potential. A master geothermal plan resource management are: has evaluated 10 potential areas. Feasibility · Political Constitution (Article 10). Designates studies have updated small-, medium-, and water and geothermal resources as national large-scale hydropower potential. Another study heritage, meaning a State-issued concession is has identified biomass potential in power required for exploitation. The Civil Code affects production. Rural electrification studies have resource management rights (inter alia with investigated the potential application of micro- regard to water resources); hydro plants and PV systems. · Natural Resources Law. Geothermal The National Energy Policy (Presidential Decree regulations were replaced by the Geothermal 13-2004) (De Establecimiento de la Politica Resource Exploration and Development Law Energética Nacional) lists key advantages of RE- (No 443-2002); water regulations will be based power policy: price competitiveness, replaced by the new Water Rights Law; foreign-exchange earnings, supply security, · Forestry Law (No 462-2003) (Ley Forestal). contribution to power-price stability and Establishes the regulatory framework for forest employment generation. This decree: resource protection and sustainable development. Dendro-energy regulations · Gives priority to exploiting national sources of consider management of secondary forests, energy supply; promotion of energy plantations and · Confirms CNE`s central role in State transformation of by-products and waste from investments in the sector and requests financial agriculture and forestry; resources to conduct prefeasibility and · Municipalities Law (Article 7). Municipalities are feasibility studies identified in the CNE plan; responsible for issuing opinions on contracts · Provides for special RE support, including CNE and concessions for natural resource studies on resource potential, promulgation of exploitation. The issuing body must receive laws promoting RE incentives and rational the opinions before issuing licenses or energy use and development of strategies on concessions;and implementing regional scale geothermal and · Environment and Naturasl Resources Law hydropower projects; (No 217-1996) (Ley General del Medio 66 Annex 1: RE Legal and Regulatory Framework Ambiente y los Recursos Naturales). Permits · INEisauthorizedtograntagenerationlicenseto resource exploitation in national parks, in establishinitial20MWwindfarmcapacity.Wind accordance with approved environmental farmdeveloperscaninstallotherwindfarmslaterif management plans. Power generation theyconduct,incoordinationwiththeNationalLoad projects over 5 MW and transmission Dispatch Center (CNDC), a system impact projects with voltages above 69 kV require analysis whose results show that the grid can EIA preparation and approval. MARENA absorb wind farm MW without negatively serves as the regulatory authority. affecting grid operating costs or power quality; · While hydropower projects have no fixed MW Economic Investment Incentives limit, they must be installed within six years of decree issuance; Under the Hydropower Promotion Law, the · Maximum tariffs are fixed at US$0.0575 for Renewable Energy Promotion Bill extends wind energy and US$0.0590 for hydropower; economic incentives from hydropower to RE they are valid for 12 years after start-up of projects generally (incentives of the Bill are operations. Consumers pay the output cost in listed in Decree 13-2004). proportion to their electricity consumption; Under the Presidential Decree 12-2004 (Wind · If more than one wind farm bidder complies Energy and Run-of-the-river Hydropower Policy) with concessions and licensing regulations, INE (Política Específica de Apoyo al Desarrollo de awards the 20 MW generation license to the los Recursos Eólicos e Hidroeléctricos de Filo de one with the lowest monomial price; and Agua) wind farm and run-of-the-river projects · INE is entrusted with adopting the necessary are given priority access to the spot market at policy implementation regulations; revised guaranteed fixed prices over a 12-year period. regulations are adopted by resolution of the Under this decree: INE Advisory Council. 67 Annex 2 Compatibility of Legal Framework with Proposed Policy Bill Promoting Electricity from Renewable Nicaragua`s Securities Market EnergySources Over the past decade, Nicaragua has developed Electricity Industry Law No 272, published in The its own modern economic public policies, which Official Daily Gazette (No 74; April 23, 1998), promote a free market, trade liberalization, free was the vital link in Nicaragua's energy sector foreign currency transactions by financial entities restructuring process; its reform objectives for the and other such economic advances, including electricity subsector were to: creation of the Securities Exchange in 1993 and the Stock Exchange in 1994. · Improve sector efficiency and competitiveness; · Introduce competition wherever economically The current Legal Framework for the Securities and technically feasible; Exchange consists of: · Facilitate insertion of private sector provision of energy services to support electricity · General Law of Banks and other infrastructure implementation requiring FinancialInstitutions; large sums of financial resources; and · CommercialLaw; · Create the necessary mechanisms to establish · General Law of Securities Certificates; short- and long-term electricity markets. · General Rule of Securities Exchange; · Internal Rule of Securities Exchange; and The reform objectives (Law No 272, Article 2) · Banking Supervision Regulations. established that activities in the electricity industry would be adjusted according to the Decree No. 33-1993, published in The Official following rules: Daily Gazette (No. 122; June 29, 1993) promulgated the General Securities Exchange · Efficiency in allocating energy resources to Regulation, whereby: provide electricity services at the least economic cost; and · The government was interested in completing the · Expansion of capacity to generate energy and development and modernization of the financial electricity services. market with issuance of the regulatory rule permittingdevelopmentoftheStockExchange;and Law No. 272 is the legal framework for · Through authorization of the Securities Nicaragua`s electricity sector and the Exchange, the development of efficient and binding legal reference for reaching transparent intermediary mechanisms was consensus on any law related to the country`s facilitated to stimulate and promote savings and electricity sector. productive investment in the country. 69 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua The regulation aims to control the brokering of production, lower long-term interest rates and transferable securities, understood as those increase income levels. This makes it especially securities that grant certificate holders rights of attractive for seeking financing of RE projects. credit, ownership or participation in the capital of legal entities (public or private), such as stock The CNE, in accordance with the general shares, bonds, short-term securities, savings plans, requirements of the Electricity Industry Law, mutual fund shares, investment fund shares and establishes that the industry`s activities will be other securities transactions that may originate adjusted to promote competition effectively and through brokerage bids. attract private capital to the sector and that provision of electricity service will adhere strictly to The existing legal framework for the Stock relevant environmental protection and Exchange is restricted, incomplete, insufficient and conservation regulations. The Commission has out of date; likewise, the volume of transactions is promoted policies and strategies that facilitate small. In response, the National Assembly is in the achieving sustainability of the country`s natural process of developing the Capital Market Bill in resources by improving the energy balance Nicaragua. At the President`s initiative, the Bill was through wind and ROR hydropower. presented on December 10, 2002 (it was to have The Environment been approved by 2005). It will provide the capital market a fully modern, legal framework with Natural Resources in the Constitution and which to broaden and develop its operations, in Nicaraguan Law addition to permitting Nicaragua`s participation in globalmarkets. The 1987 constitution and its reforms of 1995 and 2000 establish in Article 102 that "natural New concepts that the Bill lays out include resources are a national heritage." This definition paperless tradable securities, regulation of public determines what one may call the State`s eminent offerings (both sale and purchase), investment domain. In this regard, Supreme Court Ruling funds, securitized funds and company No. 101 states: administrators and risk specialists. In general, the Bill`s objectives are to regulate capital markets and "To understand this argument, this Supreme natural or legal intervening entities and related Tribunal considers it necessary to show what is the market contracts and business securities. State`s heritage and natural resources within its domain. The State`s heritage has been defined Thus, the country`s new capital market legislation as the collection of goods and rights, resources, is an excellent way to obtain financial resources and investments that, because of the constituent for developing RE investment projects. It will be elements of their social structure or as a result of possible to capture more resources for project normal activity, the State has accumulated and has development, investors will have more options, title of ownership or proprietorship with which to transactions will be streamlined and general sector assign or affect, in a permanent way, the direct or prospects will be good. indirect provision of public services in its care or implementation of its own social and economic The importance of the Stock Exchange is that it policy goals and objectives." strengthens relations between the development of the stock market and economic growth, which can The Ruling continues: "The State has sovereign help finance productive long-term projects, attract legal authority over its territory, a real institutional foreign investment, bring about jobs and greater right or, put more precisely, a fully defined, pure 70 Annex 2: Compatibility of Legal Framework with Proposed Policy property right by international law, if one complies fauna of national importance which the with its modern meaning. The State also has the people can better enjoy if placed under right to regulate all public and private property that official vigilance; it awards or concedes to private individuals, the · National Reserves: Areas under official individual substituting for the State in the exercise vigilance established to conserve and use of private rights, but the State retains a superior natural wealth; flora and fauna are accorded right to regulate property control as a social total protection compatible with the goals of function in the public interest. Some sources creating the reserves; designate this supreme right of the State as an · Natural Monuments: Areas, objects or living eminent right, in its current sense, which differs animal or plant species of scenic interest or from the old feudal right. In summary, the State historic or scientific value that are accorded has authentic property rights over the territory it absolute protection. Natural monuments are governs, according to domestic and international created to conserve a specific area, object principles or provisions of public law and, in or species of flora and fauna; they are accordance with the constitution, this property is declared inviolable, except for properly passed on to private individuals, subject to legal authorized scientific research and regulations." government inspections; and · Pristine Areas Reserves: Areas administered Continuing, the Supreme Court states in the final by authorities featuring natural flora and section of Article 102: "(The State) can sign fauna and primitive living and contracts to rationally exploit these resources when communications conditions without roads for national interest requires it." vehicular traffic that are protected from all commercial exploitation. In these final sentences, one discovers the establishment of the State`s most important In Nicaragua, conservation and development of requirement and responsibility: to establish the protected areas was initiated in 1958, when the interest of society or the public as an important Cosiguina Peninsula was declared a wildlife refuge principle. Societal interest is safe from traditional zone; 13 years later, Mount Saslaya was declared forms of protecting private interest. the first national park in the North Atlantic Autonomous Region of the country; it is now Protected Areas in Nicaraguan incorporated into the Bosawas Biosphere Reserve. Environmental Legislation The World Convention to Protect Flora and Fauna In December 1974, the first Meeting on and Scenic Beauty in Countries of the Americas, Conservation of Natural and Cultural Heritage ratified by Nicaragua in 1946, constitutes the first initiated the creation of national parks as a pilot legal instrument whose primary objective is to project for developing the country`s protected protect spaces of world ecological importance. areas system. This Convention requires states to take a series of Law No. 217, General Law of the Environment legal steps to protect their natural resources. and Natural Resources, states: The Convention establishes a series of important definitions, as follows: · Article 17: Creation of the National System of Protected Areas, which comprises all areas · National Parks: Areas established to protect and declared as such from the date this Law entered conserve natural scenic beauty and flora and into force and those so declared in the future. 71 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua · Article 18: The major objectives of the exploration and exploitation." The protected area establishment and legal declaration of natural declaration is made into law. protected areas are to: ­ Preserve natural ecosystems representative This prohibition on exploration and exploitation of the country`s diverse biogeographic and refers mainly to mining, hydrocarbons and ecological regions; forestry. With regard to hydroelectric and wind ­ Protect watersheds, hydrologic cycles, energy in protected areas, such as buffer zones, aquifers, indicators of biotic communities, such exploitation would be possible with respective genetic resources and genetic wild diversity environmental impact studies, documents and of flora and fauna; management plans; such cases are in accordance ­ Promote and develop appropriate with Law No. 272, which establishes that "the technologies for the rational and activities of the electricity industry, an indispensable sustainable improvement and attainment element for national progress, are of national of natural ecosystems; interest." Thus, in this case, national and societal ­ Protect natural landscapes and the interests take precedence. surrounding environments of historic, Concept of Public Service archaeological and artistic monuments; and ­ Promote recreational activities and tourism Public Service Concept in the Constitution in coexistence with nature. Nicaragua`s Constitution establishes the legal Likewise, the Law established the protected area framework for public service, in addition to categories, as follows: defining what are considered public services. Article 105 states: · Nature Reserve; · NationalPark; "It is the State`s obligation to promote, facilitate · Biological Reserve; and regulate provision of basic public services in · NationalMonument; energy, communications, water, transportation, · HistoricMonument; road infrastructure, public ports, and airports; the · Wildlife Refuge; access to which the population has an inalienable · Biosphere Reserve; right. Private investments and methods and private · Genetic Resources Reserve; and concessions in these areas will be regulated, in · Protected Terrestrial and Marine Landscapes. each case, by law." The development and control of protected areas In the case of public services, the constitution defines: falls under MARENA. Decree No. 14-1999 established the Regulation of Protected Areas of · The State's obligation to promote, facilitate and Nicaragua, which was published in The Official regulate the provision of public services; Daily Gazette (March 2-3, 1999); this regulation · Basic public services: energy, communications, is the instrument that captures the main aspects of water, transportation, road infrastructure, ports regulatory interest in this area. andairports;and · Specific private investment and concessions The Environment and Natural Resources Law methods regulated by law. (Article 106) establishes expressly that "renewable and nonrenewable natural resources found in The basic public services to which the constitution legally protected areas will not be subject to refers are first and foremost those that involve 72 Annex 2: Compatibility of Legal Framework with Proposed Policy individual subsistence, such as provision of potable of the property`s public usefulness or social water and other basic community services interest, this right, in practice, is subject to the without which the modern State could not exist limitations and requirements that the laws may (for example, communications, transport, ports, impose. The immovable assets mentioned airports and electricity service). above can, in accordance with the law, be the object of expropriation, advance cash payment One should note that the General Law of for fair compensation.... Confiscation of assets Telecommunications and Postal Services (Law No. is prohibited." 200, Article 9), establishes, for the first time, the concept of public service: Similarly, in the 1937 Law Bulletin, the Supreme Court establishes that expropriation is not, strictly "Public services are those that are essential and of speaking, a transfer by which one pays for the utility and importance for the majority of the price of something; rather, it is a forced cession, country`s residents...." conducted in the social interest, for which one makes reparations for the damage caused. Since electricity generation is considered a public service, its generation using RE thus falls Thus, to guarantee development of the electricity within this concept. industry activities, property can be declared useful through an administrative process, and just Rights and Declaration of Public Usefulness compensation must be paid in advance to make Law No. 272, Article 3, states that "activities of the expropriation effective. electricity industry, being an indispensable element Creation of the Energy Sector Power Broker of the nation`s progress, are of national interest;" therefore, private and State property and rights The Electricity Industry Law establishes economic can be affected by the rights or declaration of agents as those that develop electricity industry public usefulness. activities, such as generators, distributors, transmitters, and self-producers; no market activity Stating that electricity industry activities are of is created in the electricity market per se. national interest is equivalent to saying that they are of general interest. The law sets forth how Despite this, Law No. 272, Article 110, states: rights can affect property through soliciting concessions or licensing title and taxes by the The free price regime comprises electricity regulatory entity. It also permits establishing transactions between generators, cogenerators, mutually accepted rights between parties without self-producers, distributors, marketers and regulatory intervention; that is, the law large consumers. anticipated the two possibilities: with and without regulatory intervention. In formulating Law No. 272, the power-broker was much debated; it was argued that the cost of With regard to the effect of public usefulness on surplus energy would increase. But the Law refers property, Article 44 of the constitution clearly to power-brokers as distinct from distribution, establishesthat: laying the foundation for developing the concept. "The private-property rights of movable and Consultations with both public and private agents immovable assets, as well as the instruments and about the power broker concluded that the methods of production, are guaranteed. By virtue marketing activity would not be viable in the 73 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua current context, given that there is only one buyer Article 41: "Distributors generally cannot transmit and the market is generally small; basically, it electricity. Without affecting what is set forth would raise costs, which would result in increased above, distributors can own secondary tariffs, one of the sector`s major problems at this transmission systems to be connected to the SIN." point of time. Law No. 272 clearly prohibits owners or Conversely, if one could dispel the belief and shareholders in generation, transmission and demonstrate that the power-broker activity distribution firms from participating in more than would lower transaction costs, it would become one electricity industry activity in order to prevent viable. In any case, it would require an an industry monopoly and so that integrated firms, additional reform to the Electricity Industry as was the State firm before the electricity sector Law, which would create the power-broker restructuring and reform, comply, thereby bringing activity as such and the economic agent of about competition in each industry activity; the the marketer. general rule is that a generator cannot be a distributor and vice versa; likewise, economic Law No. 272 establishes in Articles 26, 29, 34 agents in transmission cannot buy or sell electricity. and 41 how to avoid the formation of monopolies in the electricity industry and vertically integrated However, Law No. 272 also anticipates exceptions firms, as follows: to this rule, as follows: Article 26: "Economic agents, subsidiaries and · Generators can own secondary transmission shareholders dedicated to generation activities systems connecting their stations to the SIN; cannot be proprietors or shareholders of · Isolated system generators can set up transmission installations and/or distribution. integrated firms and participate in transmission and/ordistribution;and "Without affecting what the above paragraph sets · In cases where generation is connected to forth, generators can own Secondary Transmission the SIN, a generator can own a distribution Systems which will be connected to the National system, if the combined generation is less Interconnected System (SIN)." than 10,000 kW. Article 29: "Economic agents dedicated to the Decree 12-2004 activity of transmission cannot buy and/or sell electricity." Publication of Decree 12-2004, which established the specific policy supporting development of wind Article 34: "Economic agents that own lines and and run-of-the-river hydropower resources, other components of the distribution system are caused a great controversy in the National required to give other economic agents and large Assembly`s Infrastructure, Energy and consumers permission to connect to their Transportation Commission, given that it installations, in compliance with rules that control established maximum monomial prices of the service and corresponding payments. US$0.0575 and US$0.0590, which encroached on the regulatory entity`s authority until affirmed "Only distributors, including any subsidiary or by the National Assembly. associate, that have a combined generation capacity of up to 10,000 kilowatts (kW) when But these concerns are excessive. Perhaps the interconnected to the SIN can provide greatest controversy derives from the perspective distribution service." of the nascent party itself; generally, Decrees of 74 Annex 2: Compatibility of Legal Framework with Proposed Policy the President of the Republic, referred to as · Control, supervision and regulation of all regulations, occur when a law specifically sets public services contained in only one legal forth that it should be regulated and exactly which regulatory body; Articles must be regulated; in the case of this · Election by the National Assembly of a public Decree, no law is referred to. services supervisor and four administrators, supposedly to guarantee independence Although Article 150 of the constitution states: and objectivity; "The following are attributions of the President of In Chapter III of the Energy Sector Administration the Republic: To pronounce Executive Decrees in Bill, sector functions are defined as follows: administrative matters...." · Supervise compliance with norms, criteria, One can infer that establishing maximum specifications, technical rules, and regulations wholesale energy prices is an administrative governing the inspection, exploration, matter; Law No. 272, Article 109 of the Tariff exploitation, utilization, production, transport, Regime, states: transformation, distribution, management, and "For the purpose of this Law, the Tariff Regime use of energy resources in conformity with is classified in the Free Price Regime and the energy regulations and policy; Regulated Price Regime. In the Free Price · Produce, put into effect and supervise Regime, transactions are carried out without compliance with rules and regulations designed State intervention. In the Regulated Price to exploit energy rationally and efficientl; Regime, transactions are remunerated via INE- · Produce, put into effect, and supervise approved prices." compliance with technical rules and regulations on electricity generation, transmission, Article 110, Free Price Regime, comprises distributionanduse; electricity transactions among generators, · Award, modify, extend, or cancel inspection cogenerators, self-producers, distributors, permits for any energy source; marketers, and large consumers. · Ensure that electricity service runs smoothly and define indicators of quality, reliability Public Services Superintendence Bill andsafety; The energy, telecommunications, potable water, · Approve, publish, and control the toll for and sewage and sanitation sectors will be affected use of electricity transmission and by creation of the Public Services Superintendence distributionnetworks; Bill, approved by the National Assembly`s · Apply sanctions in cases anticipated by laws, Communications, Transportation, Energy and rules, regulations, concessions, and licensing Construction Commission (June 9, 2004). contracts and other dispositions; · Resolve controversies between economic This Public Services Superintendence signals a agents who participate in the energy sector, significant change in how the country`s basic according to what is set forth in the Electricity public services are organized. The basic IndustryLaw; argument for creating it is the State`s duty to · Award, extend, declare the expiration of, or guarantee quality control of goods and services cancel energy generation and transmission and provide the population these basic services. licenses, as well as distribution concessions; This means: · Supervise compliance with the exercise of 75 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua rights and responsibilities of license holders products and services regulated in the andconcessionaires; electricity subsector; · Designate inspectors, where appropriate; · Supervise compliance with environmental · Establish categories of large, medium and protection regulations by license holders small consumers, based on technical and andconcessionaires; economic parameters when the law or subject · Establish and maintain the information system determines it; of the sector`s most important variables; · Approve and inspect the work and · Develop and present the executive office installations of license holders and sector-related bills to be considered by the concessionaires for electricity generation, legislature;and transmission, and distribution; · [Conduct] any other function the Law grants · Approve, inspect and control the within its scope. measurement instruments installed by concessionaires and license holders for the This proposal has its opponents within the electricity production and delivery registry; executive branch, regulatory entitites and even the · Prepare and adopt the necessary World Bank public opinion; but the project measures to avoid restrictive competition continues moving forward and [was] expected to practises in supplying or providing be approved in November 2004. Table A 2.1: INE Opinion on the CNE Bill Promoting RE Generation (US$ per kWh) INEOpinion Comments Article 2. Definition. The These definitions are already Even though these definitions are following definitions are established in Article 8 of the well defined in Law No. 272, it is established for this Law: Electricity Industry Law valid to include them for reasons of consistency with the new law Economic agent: Any qualified individual or legal entity residing in the country that develops well defined activities in the electricity industry under any ownership regime Generation activity: Electricity production requiring the exploitation and transmission of any energy source Article 2. The Nicaraguan State, ItissuggestedthatCNE,the via the Nicaraguan Energy responsibleentityforplanningand Institute (INE), will offer all the defining the country`s electricity incentives contained in the current sectorstrategies,notINE,the Law to national and foreign established regulatory entity, certify investors who qualify as economic investor-relatedincentives,using agents, in accordance with the them to steer investment toward RE (Continued...) 76 Annex 2: Compatibility of Legal Framework with Proposed Policy (...Table A 2.1 continued) (US$ per kWh) INEOpinion Comments Electricity Industry Law, Rule and Regulation on Licenses andConcessions Renewable Energy Article 68, Law No. 272, sets This apparent contradiction can Generation Project forth:"The implementation of be resolved by stating that this (PGEFR) Preparation studies for electricity generation period will be authorized, rather Period: Period in which stationsusingnatural than verified, by the INE activities related to resources...requires a provisional feasibility studies and final license granted by the INE for a project design (not maximum period of two years" including concept and prefeasibility stages) are Article 3. To implement studies implemented under the for electricity generation stations appropriate license and/or using natural resources, concession. The duration economic agents must obtain the of this period, along with relevant provisional license, in CNE certification and its accordance with the Electricity development, will be Industry Law (Articles 68 and verified by INE 116 and following Regulation) Isolated system: The This term is already defined in Even though this definition is electric power station or Law No. 272 already there in Law No. 272, combinedstationsof including it here facilitates its use generation,transmission by users and operators and distribution systems not interconnected to the NationalTransmission System Article 5. National interest Law No. 272 has already The concept of national interest is is declared as the rational established that activities of the critical in this Law; energy developmentand electricity industry are of national generation involves using natural exploitation of RE interest resources in protected areas and resources their buffer zones. Thus, it is valid to expressly state independently in this Bill what is set forth generally in Law No.272 Article 6. Certification: The Article 71. Law No. 272, There is no contradiction, given CNE will certify, in Regulation: A work project must that CNE will only certify; the accordance with what the be carried out in accordance with Article does not state that CNE current law and its the technical rules and principles will authorize or establish regulation require, that INE draws up and must take technical rules and principles. authorization of a PGEFR, into account the general urban Logically, however, it should be specifying a maximum development plans in effect assessed whether adding another operational period for this step makes the process more classification so that the bureaucratic; generally, any project begins its additional steps in the preinvestment work. Once administrative process are not preinvestment is initiated, advisable (Continued...) 77 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua (...Table A 2.1 continued) (US$ per kWh) INEOpinion Comments the term can be extended Expansions that require licensing INE`s opinion is valid, given that with due justification, are already anticipated in the the procedure for such cases is according to the current rules of Concessions and already established. The Bill Law`sregulation Licenses, Chapter 2.3a: incorporates CNE certification so Generation Licensing and/or that the economic agent that Expansion wishes to carry out expansions can benefit from the incentives Article 7. Expansion: Article 4 states: "Economic established in the Law. This would PGEFR economic agents agents of operative Electricity add another step to the process, who wish to substantially Generation Projects who wish to making it more complicated expand their installed substantially expand their capacity can solicit it from installed capacity can request it CNE, requesting a PGEFR from INE, in accordance with the to benefit from the new established rule of Licenses and investment incentives set Concessions. Once the contract forth in the new Law addendum is signed, they can take advantage of the new investment incentives under the current Law" Tax Regime This is not feasible; regional market rules should be applied Article 5. Economic agents will Similarly, in reference to PGEFR be free to export the energy certification to determine the generated, minus a percentage, actual period within four years annually fixed by the regulatory that will be applied to exonerate entity, which will target domestic payment of income and consumption municipal taxes, INE proposes eliminating CNE`s role. This should be assessed based on what is more advisable for promoting RE investments; the deciding rule must be used to make these types of decisions Article 10. The tax Article 6. The tax incentives and The opinion insists on eliminating incentives and benefits benefits established in the current CNE as the one that certifies so established in the current law will be administered by the that investors can access Law will be administered MHCP, on authorization of the incentives; similarly, it eliminates by the Ministry of Finance regulatory entity, which must the Ministry of Development and Public Credit (MHCP), supervise work progress and Industry and Trade (MIFIC) on authorization of the require compliance with Ministry of Development, obligations of the economic Industry and Commerce agents and CNE certification Note: Generally, INE`s organizational contributions to the Law are positive, but its core motions are to eliminate CNE`s certification role so that investors can access incentives; this platform must be analyzed, assuming that the deciding rule is to direct efforts to promote RE generation investments in order to diversify the energy matrix. Thus, insofar as possible, a flexible mechanism should be created that avoids bureaucracy and smoothes the access process. CNE`s certification role is interesting from the perspective of defining the country`s energy sector strategy and planning; if this mechanism helps CNE fulfill its role as a promoter of investment in RE production, it should be allowed the certification role. 78 Annex 3 International Experience with RE Frameworks This Annex reviews successful international OECD Countries: Carving Out a Wind Farm experience with RE frameworks of relevance to NicheMarket Nicaragua. The first section considers wind energy policies in countries of the Organisation In OECD countries, hydropower resources are for Economic Co-operation and Development nearly fully exploited. Large-scale promotion of (OECD). The second one summarizes lessons new sources of RE generation focuses on from emerging economies in attracting biomass-based power, geothermal energy, wind private investment to small-and large-scale energy, and, to a smaller extent, wave energy. hydropower. Finally, the third offers regionwide Wind energy, however, is the outstanding policy lessons from Central America, as well as success story in terms of installed MW. A range country-specific experience from Costa Rica, El of instruments have been used to carve out Salvador, Guatemala, Honduras and Panama. a niche market for a commercially nonviable technology. OECD country experience underscores the importance of having quantified policy targets The experience of OECD countries underscores and providing markets the needed instruments the importance of setting quantified policy to achieve them. In emerging economies, targets and providing the market the instruments small-scale hydropower schemes emphasize needed to achieve them. Countries that have private sector investors' need for a certain tariff introduced the mandated market approach ­ regime and sales conditions. For large-scale either the mandated tariff or the mandated hydro, it is possible to find willing investors ­ quantity variant ­ have achieved large-scale RE even in difficult country environments like penetration; in countries that have not used this Nicaragua ­ if long-term Power Purchase tool, RE remains a marginal option. Agreements (PPAs) can be signed. In Central America, all of the countries which Of the two variants, the mandated tariff implemented power sector reform have approach results in faster, more dynamic experienced similar problems, including market development, but the incremental difficulty in passing parliamentary-approved subsidy cost per installed MW is slightly water laws and a bias toward power sector higher. But there are ways to reduce the investments with short payback periods. Costa size of the surcost (and the economic Rica, in stark contrast, demonstrates the rent of wind farms at sites with the best wind demand- and supply-side advantages of regimes). For example, the premium tariff maintaining State control over the entire vertical can be limited to a fixed number of GWh hour chain, from generation to distribution. per installed MW. The difficulty of designing a 79 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua mandated quantity scheme should not be In no country with a small-hydro promotion underestimated.84 scheme is the private developer exposed to a fully liberalized power market.87 The starting point for In OECD countries, widespread adoption of the such tariffs is generally avoided costs or long-run mandated market approach has shifted the marginal costs, as specified by the grid operator or balance away from taxpayer-paid subsidies toward national utility. If the avoided-cost principle in consumer-paid electricity subsidies. A second thermal power were interpreted strictly, the PPA strong international tendency has been the tariff would be adjusted regularly, being indexed to increasing elimination of special market and a range of variable cost elements in thermal pricing rules for wind energy. Rather than a fixed power. A key variable would be fluctuations in the tariff, the tendency has been to give renewable fuel price that power plants use. Such a direct link generators a premium per kWh on top of the pool would undermine an advantage of expanding the price, with an overall price cap (power pool tariff, percentage of RE systems in national power plus premium), which eliminates the premium if supply: to introduce an element of price stability power pool prices are above a ceiling price. into the power market and protect the economy against the risk of tariff increases over the long Emerging Economies: Attracting term. The avoided cost-pricing principle is, Private Investment therefore, applied differently in the national In emerging economies, there is still large scope schemes. Variations concern whether: for developing small- and large-scale hydropower. · The tariff is differentiated according to the time Thus, mass RE penetration into the bulk power of power supply (avoided cost of thermal market depends on hydropower investments. power depends on the time of day). Because of Small-scale Producer Schemes the flexibility in adjusting the level of power output from a hydropower plant, it is For emerging economies like the OECD countries, advantageous to provide project developers the certainty of the tariff regime and sales conditions is right price signals with regard to the value of critical for the private sector.85 Published tariff adding limited storage capacity to the schemes and associated model PPAs for small- hydropower dam. Yet, countries apply different scale, grid-connected schemes are an effective payment policies for time variations in the key for unlocking private investment in power value of supplied power; one can observe: generation; where developers must negotiate PPAs 1) fixed kilowatt-per-hour tariff, irrespective of individually with the off-taking utility, private sector season and time of day; 2) seasonal variations interest in small hydro is limited.86 in annual tariffs (the kW-per-hour tariff paid is 84Associated transaction costs are higher for a mandated quantity scheme than for a mandated tariff scheme. In mandated tariff schemes, the economic terms and conditions of contracts are law-based; contracts between wind farms and other power market operators become formal confirmation of the economic conditions defined by law. Contracts may even not be used (e.g., Denmark in the 90s) or are standard documents stating that power off-take is paid according to terms defined by law. By contrast, mandated quantity schemes are contract-based; the economic terms and conditions for power off-take and grid use are not defined by law; rather, they are the outcome of negotiated deals between commercial parties. Thus, for wind farms, the economic terms are defined in the details of the commercial contracts that link wind farms to the power market. 85This section draws heavily on Scheutzlich (2004) and Ferrey (2003). 86The share of renewable small power projects to the national electricity supply is 2 percent in Sri Lanka and nearly 4 percent in both India and Thailand. Standard PPAs with standard tariffs are a powerful instrument for all grid-connected, private power investment. In Latvia, published power tariffs for combined heat and power plants with less than 5 MW output of electric power have quickly resulted in private industrial companies seizing the opportunity. 87The definition of small-scale differs. In the five Asian countries analyzed by Ferrey (2003) ­ India, Indonesia, Sri Lanka, Thailand, and Vietnam ­ the cut-off rate range was 20-50 MW. 80 Annex 3: International Experience with RE Frameworks higher during peak than off-peak season); and Observed solutions include: 1) a single, above 3) daily peak and off-peak tariff. Indonesia avoided-thermal-cost tariff to all small hydro uses steep incentives for on-peak hourly projects; 2) power purchaser payment of a delivery of small power producer (SPP) power fixed avoided-cost tariff (or the pool market and decreases off-peak hourly prices so that price) on top of which the small-hydro plant is the weighted average tariff equals avoided paid a fixed RE premium from a fund; and cost. Sri Lanka uses a seasonally differentiated 3) an RE premium established on a project-by- tariff to reflect peak system premium project basis through periodic tenders for a requirements. In India, the state of Tamil Nadu specified number of MW(s), awarded to the provides a higher tariff to base-loaded biomass bidder, asking for a minimum subsidy per kWh. projects than to intermittent wind projects; ComparedwiththeSPPtariffsinothercountries, · The tariff is adjusted periodically during the Nicaragua'sUS$5.9perkWh(offeredunder contract years and how the adjustment is linked PresidentialDecree12-2004)isgenerous.Nepalhas to specific indexes (avoided costs change respective dry- and wet-season tariffs of US$5.9 during the years due to changes in fuel prices, and 4.2 per kWh. Indonesia's tariffs are US$4.1- general inflation and the exchange rate). Tariff 5.2 per kWh, Sri Lanka's are US$5.2-5.4 per escalation (linked to the dollar or oil price) is kWh; while that of Himachal Pradesh (India) is usually specified for the first five years from US$5.5 and the Philippines is US$3.4. contract signing so that the developer can meet In Thailand and Indonesia, PPAs for firm supply debtpayments; are 20 years, while those for nonfirm supply are · Payment is split into a capacity payment kW limited to five years. Sri Lanka and Andhra tariff) and an energy payment kW-per-hour Pradesh (India) do not distinguish between firm tariff) (short-term avoided cost refers to savings and nonfirm hydro; PPAs are for 15 and in variable cost, mainly that of fuel; long-term 20 years, respectively. avoided cost includes savings in thermal capacity). In terms of separate recognition of Not all programs pay the long-term avoided cost capacity value, one can observe various for long-term firm power commitments. Some practices: 1) standard energy payment kW-per- countries pay short-term energy-only avoided cost, hour tariff) for all RE generators; 2) energy regardless of the type of PPA obligation. payment higher for firm power than Generally, payment is based on bulk energy intermittent power; and 3) separate payment supply without considering capacity (i.e., the utility for energy (kilowatt-per-hour tariff) and must keep capacity reserves in order to maintain capacity (tariff per MW of firm capacity); and adequate supply security). · Subsidies are paid on top of the avoided cost Many dispatch centers consider it noneconomic to tariff (for reasons of power supply diversity, a include small hydro plants below 10 MW capacity country may wish to develop hydropower sites in the grid operator's dispatch regime. For small whose production costs are higher than those isolated (diesel) grids, this capacity limit may be of thermal power). Power subsidies from small- lower, and the small hydro plant may have to scale RE generators are fixed and are assume grid stability and deliver firm capacity administered differently in country schemes. against proper reimbursement.88 88Indonesia`s first small private power program in 1997 provided for firm-capacity payments, but developers voiced concerns over complex definitions. With regard to small isolated diesel grids, the question was who would be allowed to provide the base load (i.e., the small hydro or grid operator). 81 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua In Himachal Pradesh and Nepal (to a certain gives a first possible layout of a small-hydro project, extent), provision is made for so-called "deemed includingheat,flow,poweroutput,distancetoroads, generation." If the grid operator cannot take andinterconnectionpointsorloadcenters. power from the small hydro generator for more than 20 days per year, s/he pays for an estimated Large-scale Hydropower for the amount of energy not taken off (estimates are Regional Market based on actual generation in previous years). For Nicaragua, establishment of power pools at In many developing countries, the financial the regional level ­ the medium-term vision for standing of utilities and grid operators is relatively Central America ­ would also, in theory, facilitate poor, and small hydro developers fear that establishment of larger-scale hydropower plants payment for energy supplied might be endlessly in-country. The ideal investor would not insist on delayed. Himachal Pradesh provides for selling all output via a long-term PPA before government guarantees in the event of a default construction; rather, s/he would sell portions to by the public grid operator. distribution companies and final industrial consumers and into the power pools (using long-, Forprivateinvestors,identificationofsmall-hydro medium-, and short-term contracts and daily and project sites is a lengthy process with high upfront hourly pool bidding) (Figure A3.1). costsassociatedwiththeriskthatafeasibleand attractive project would not be found. In certain Merchant plants generally have fallen out of favor countries,amasterplanwithpreidentifiedsmall- with investors. In addition, the free power market hydrositeshasbeenpublishedandpromoted disfavors investments in capital-intensive plants, as among private developers and investors. The master the risks for default on loans caused by plan serves two purposes: 1) It specifies those sites temporarily low power prices (in times of not earmarked for other water development projects overcapacity, pool prices drop to the marginal (large-hydro, irrigation and water supply); and 2) It short-run cost of production) are higher for plants Figure A3.1: Organization of IPP Merchant Plant National Power Pool Distribution Distribution Company C3 Company C1 Hourly Sales 10-year 15-year PPA IPP PPA Manufacturing Merchant Company C1 11-year Plant PPA 5-year PPA Manufacturing Day-to-day Company C1 Sales Export Distribution Power Pool Company C2 82 Annex 3: International Experience with RE Frameworks with high fixed costs of production. It is difficult to RE Policies in Central America secure financial closure for hydropower plants without a long-term PPA. In Southeast Asia, Laos In 2000, the six countries of Central America ­ has succeeded in attracting foreign investment to Costa Rica, El Salvador, Guatemala, Honduras, larger-scale hydropower plants, mainly for Nicaragua, and Panama ­ had a total production export to Thailand; the State benefits population of 36 million.89 In 2002, the Gross via payment of a water-use royalty per kWh of Domestic Product average (GDP) per capita was output. In Laos, the ability to sign long-term PPAs US$1,900 in current dollars. Costa Rica had for most plant output with the Electricity the highest electrification rate (95 percent), Generating Authority of Thailand (EGAT) made the while Nicaragua had the lowest (47 percent). project possible. In Uganda, the 250 MW Bujagali, under development by AES Corporation, was Share in Regional Power Supply never implemented, even though a PPA had been At the end of 2003, RE share in total annual signed and the International Finance Corporation power generation for the six countries was 59 (IFC) was cofinancing the project and providing a percent, representing a 32 percent decline partial risk guarantee. Beyond corruption scandals, from 1990 (Table A3.1). Costa Rica topped the which had already marred the project, the State- list at 98 percent, while Nicaragua was at the owned national transmission company in the PPA bottom with 23 percent. Conversely, in terms of was to accept a take-or-pay for the large output share of petroleum consumption used for power increment, although demand in Uganda was generation, Nicaragua was first (36 percent), growing by less than 20 MW per year. AES never while Costa Rica was last (2 percent). Costa tried to obtain part of the output sold to Kenya. Rica had the highest share of commercial The positive lesson from international experience energy in final energy consumption with private investment in large-scale hydropower ss(92 percent), while Nicaragua had the lowest is that it is possible to find willing investors ­ even (40 percent). Foreign private investment in for difficult country environments ­ as long as a generation went into oil-fired power plants and long-term PPA can be signed. a single coal-fired plant (Box 4.1).90 Table A3.1: Percentage of RE in Central American Electricity Production, 1980-2002 Year Region CostaRica ElSalvador Guatemala Honduras Nicaragua Panama 1980 71.1 98.8 98.7 20 91.6 53.7 55.0 1990 91.1 98.7 93.6 92.3 100.2 61.2 84.0 1998 60.4 92.4 53.0 55.4 54.3 21.8 51.3 2000 67.0 99.1 57.6 54.2 60.5 16.9 70.5 2002 59.1 98.4 50.6 40.6 38.7 23.4 64.7 Source: Economic Commission for Latin America and the Caribbean (ECLAC). 89In 2000, country populations were 3.6 million (Costa Rica), 6.1 million (El Salvador), 11.4 million (Guatemala), 6.5 million (Honduras), 5.5 million (Nicaragua), and 2.8 million (Panama). 90Information in this section is largely drawn from Economic Commission for Latin America and the Caribbean (ECLAC) (2004). 83 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua Decline in RE share occurred despite Central 2010 and making better use of its comparative America's enormously identified potential for advantage in RE resources); Brazilian Renewable hydropower (24,000 MW) and geothermal Energy Platform, 2003 (part of a regional RE (2,100 MW), as well as high-quality wind farm conference held in Brazil); and Central American potential in Costa Rica (600 MW), and Nicaragua Sustainable Development Alliance (ALIDES), 1994. (200 MW) (Table A3.2). Major regional organizations include the Central American Electrification Council (CEAC), Central Regional Policy Initiatives America Coordinated Association of Electricity Regulatory Bodies (ACERCA) and the Regional Although RE share fell in all Central American Commission on Water Resources (CRRH). countries except Costa Rica, all six had signed high-profile, regional policy declarations in favor Country Policy Summaries of RE. Major declarations include the Latin American and Caribbean Sustainable CostaRica Development Initiative (ILAC), 2002 (approved during the Environment Ministers Meeting in In 2002, Costa Rica had an installed capacity of Johannesburg, which committed the region to 1,796 MW, the largest in Central America. having 10 percent of its power supplied by RE by Renewable generators, which accounted for 98 Table A3.2: Electricity IndustryVariables for Central America, 2002 Year Region CostaRica ElSalvador Guatemala Honduras Nicaragua Panama Installed 7,898 1,796 1,136 1,703 1,073 659 1,533 Capacity (MW)* Electricity 29,730 7,035 4,658 5,806 4,577 2,410 5,243 Demand (Production, plusNet Imports, GWh)** Maximum 5,170 1,221 752 1,119 798 422 857 Potential Demand (MW)*** Net Energy Production, by Source (%) Total(GWh) 29,724 7,439 4,274 6,191 4,162 2,402 5,257 RE Source (%) 59.1 98.4 50.6 43.7 38.8 23.4 64.7 Hydro 48.7 80.2 27.6 32.5 38.7 12.5 64.6 Geothermal 7.9 14.6 21.9 2.1 0.0 8.0 0.0 Cogeneration 1.7 0.1 1.1 9.0 0.1 3.0 0.1 Wind Energy 0.9 3.5 0.0 0.0 0.0 0.0 0.0 Source: Economic Commission for Latin America and the Caribbean (ECLAC). * Installed capacity only includes national interconnected systems. ** Domestic consumption at wholesale or high-voltage levels. *** Maximum regional potential is not coincident. 84 Annex 3: International Experience with RE Frameworks percent of generation, consisted of hydropower agency responsible for regulating power, (80 percent), geothermal (15 percent) and wind telecommunications, hydrocarbon, irrigation, energy (4 percent). public transportation, maritime and air services, rail cargo transport and waste disposal ­ is in Costa Rica's power sector policy has four charge of setting tariffs, sector oversight and distinguishing characteristics: organizing public auctions to award independent generation projects. · The State-owned, vertically integrated power utility plays a dominant role; Regulations strongly favor RE power generation; · Private Independent Power Producers (IPPs) major ones have included: can invest only in RE generation projects; · Long-term PPAs (of up to 20 years) can be · The 1949 law creating ICE, which signed with plants whose capacity is larger than directly entrusts it with development of 20 MW (a public tender is required); and the country's physical resources, · The law actively promotes participation of the especially hydropower; Costa Rican citizenry in private power projects · Organic Environment Law, which states that (national investors must provide a minimum of Costa Rica's RE resources have an essential 30 percent ownership in an IPP project).91 role to play in sustainable development, which the State is responsible for promoting; The Costa Rican Electricity Institute (ICE), the · MINAE-issued decrees, providing State-owned, vertically integrated utility, RE-resource incentives; generates more than 90 percent of the · Parallel Autonomous Generation Law, which country's electricity through National Power and authorizes ICE to purchase up to 30 percent of Light Company, S.A. CNFL, a subsidiary the national required power capacity and distributor in the capital city of San Jose; this is energy from IPPs, provided they use RE (this the largest market (75 percent), which acts as law has driven development of private single buyer for IPPs. Two integrated municipal investment in RE generation); and utilities and four Rural Electric Cooperatives · Rural Electric Cooperatives and Municipalities (RECs) provide distribution service in areas Participation Law, which regulates how entities beyond San Jose. created by these bodies obtain concessions for Since 1990, a handful of small independent hydropower plant investment. generators selling power to ICE under long-term All power projects must be compatible with the PPAs have entered the market. These include National Energy Plan, one of whose objectives three wind farms and one geothermal power plant is to continue development of alternative energy (to which ICE sells steam).92 resources. This includes meeting the target to The Ministry of Environment and Energy (MINAE) increase RE share (other than hydropower) performs policy functions. The Regulatory Authority in generation to 15 percent of the national for Public Services (ARESEP) ­ a multisector power production. 91This condition is difficult to implement in practice. Foreign investors can easily circumvent restrictions on percentage of foreign ownership by finding a local "straw man" with little or no capital; they lend the straw man the required national equity capital under a shareholder agreement that limits his voting rights and allows him to access dividends first when the loan has been repaid. 92A cap on the country`s debt (imposed by the IMF in the mid-90s) had created a situation in which public utilities raised tariffs but could not reinvest the resulting revenues in the respective sector. 85 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua As a result of the Costa Rican government's policies The government of El Salvador is considering a and regulations ­ the long-term PPA being the major policy initiative, known as the Renewable primary tool ­ plants using fossil fuels have been Energy System Development (SIFER). It would unable to penetrate the country's market. The PPA establish :1) the Guarantee and Stabilization Fund structure,withitsseasonal-andtime-of-day (FOGES) for RE projects; 2) guides for making differentiated tariffs, merits replication in Nicaragua. maximum use of "green electricity funds" (including the Clean Development Mechanism, ElSalvador CDM) and 3) tools for comparative cost-analysis of options; and 4) a proposal for a wholesale power In 2002, El Salvador had an installed capacity of broker, who, inter alia, would sign long-term PPAs. 1,136 MW; that year, RE generated 51 percent of total power, 28 percent of which was provided by Guatemala hydropower and 22 percent by geothermal energy.93 The country is Central America's largest In 2002, Guatemala had an installed power consumer of geothermal energy. Its two main capacity of 1,703 MW; that year, RE provided geothermal facilities are Ahuachapan 44 percent of the power generated, comprised of (Ahuachapan Province), with a 95 MW generating 33 percent hydropower, 9 percent biomass-based capacity, and Berlin (Usulutan Province), with a cogeneration, and 2 percent geothermal energy. 66 MW generating capacity. Demand growth calls for an additional 90 MW capacity per year.94 A geothermal law supports private development. MARENA, responsible for water The government of Guatemala took a strategic management policy and legislation, has approach to power sector reform. It privatized all prepared a bill for a General Water Law. State-owned assets, with the exception of Concurrently, the Superintendent of Electricity hydroelectric and transmission assets, which and Telecommunications (SIGET), the power remained under the National Electrification sector regulator, has issued regulations to Institute (INDE). facilitate administrative processes for obtaining geothermal and water concessions for smaller- The privatization process aimed to rapidly develop scale projects. private investment in generation and rural electrification. Two thermal-fired generating units, The first RE law, adopted in 1986, was replaced in owned by the Guatemala Electric Power Company 2003 by the Renewable Energy Development (EEGSA), were sold for US$30 million to the Incentives Law, which instructs the Ministry of Energy Guatemala Generating Group (GGG) (controlled and Mines (MEM) to conduct resource surveys and by Constellation Power), securing a 18-year PPA provide investment incentives (for example, that allowed the winning bidder to construct up to exemption from import duty and VAT and 10-year 150 MW of new capacity on a Build-Own- tax holiday on income and property taxes). Operate (BOO) basis.95 In 1998, EEGSA's urban 93 El Salvador has the second-highest credit rating of all countries in Latin America. 94 Guatemala, Central America`s only oil-producing country, is the region`s largest economy, with a GDP of US$18 billion. 95 The GGG`s 18-year PPA allowed the group to construct up to 150 MW of new capacity, with free choice of site, fuel and technology. During the first three-year phase of the PPA, GGG sold EEGSA 80 MW of output from existing units they recently acquired, providing part of the cash needed to build the plant that would sell power on a dispatchable basis over the next 15 years. Follow-up investment was in the 120 MW San Jose coal plant and the Orzunil geothermal project. 86 Annex 3: International Experience with RE Frameworks distribution assets were privatized when 80 The National Electricity Commission (CNE), percent was bought by the Central America created in 1996 as an independent agency under Energy Distributor, SA (DECASA), a consortium the MEM, is responsible for market oversight. It of Teco Power Corporation of the United States, sets market rules and procedures and oversees Iberdrola Energy, SA of Spain and Portugal market-agent behavior. It also regulates electricity Electricity, SA INDE's rural distribution assets law and defines transmission and distribution were privatized; proceeds remained in a tariffs. The General Energy Administration (DGE), rural electrification fund, which the rural responsible for sector policymaking and planning, concession holder (Union Fenosa won the may, in certain extreme cases, require tender for both concessions) could draw on to transmission and distribution companies to finance 100 percent of the cost of rural undertake targeted system expansion projects in electrification investment.96 return for government payments and guarantees. The investment framework for generation is clear. Demand-side conditions, apart from the overhang At the wholesale level, companies compete in two of long-term PPAs with EEGSA and INDE,97 are markets: 1) deregulated contracts market; and conducive to investments in new generation as 2) spot market. The wholesale market demand grows 80 MW per year and there are administrator is a private, nonprofit company. several off-takers. Electricity generation is open to any entity, and Guatemala has a long history of promoting private projects under 5 MW do not require specific sector investment in RE. The first RE law, adopted government authorization other than what the in 1986, was in force until 2003 when it was constitution and related laws stipulate. Distributors replaced by the Incentives for the Development include one large urban company, one large rural of Renewable Energy Projects Law (Decree company, and 14 smaller Municipal Companies 52-2003). In 1993, INDE signed its first PPA with (EEMs), which account for 5 percent of demand. a private developer for a 12 MW hydropower Electricity Law regulations classify clients with plant. In 1996-97, a private developer's PPA power demand above 100 kW as large users; application for a proposed 20 MW wind farm was they are not subject to regulation and can freely put on hold, pending sector reform. But no new negotiate power supply conditions with distributors renewable generation plants have come up since or other suppliers, including generators and privatization, in part, because Parliament has not dealers. Independent power retailers or wholesale passed the Water Resource Law. However, the brokers are free to operate in the market without a main reason is the inability to sign long-term license; but they must buy and sell a minimum of 10 PPAs with INDE. MW. In 2004, there were 11 retailers. Marketers, distributioncompaniesandlargeconsumersare Decree 52-2003 instructs MEM to undertake required to hold contracts that cover their capacity resource surveys and provide a range of and energy requirements for both the current and economic and fiscal incentives (e.g., tax subsequent year. This restriction puts most exemptions on imports of relevant RE equipment generation under the contracts market. and for companies implementing such projects, 96The subsidy of US$600 per connected consumer was more than enough to cover the cost of the rural investment program. However, the subsidy only covered new consumers located more than 200 meters from the distribution grid of the concession holder (i.e., outside the concession area). The concession holder charged consumers beyond the 200 meters a low connection fee, and those within the concession area a high fee, thereby discouraging low income households from connecting. 97INDE resells this power to distribution entities. 87 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua elimination of the VAT and a 10-year tax holiday hydropower plants below 50 MW had a dispatch on RE investments). MEM's recent activities include guarantee (under Decree 9-2001). ENEE was creation of the Center for Renewable Energy required to purchase from private producers (this Information and Promotion and introduction of a requirement will change once the new electricity Bill for a biofuel law. law comes into force, under which ENEE will be sold to a private owner). The limit for small Honduras hydropower plants with special incentives was 20 MW. A special decree allowed private wind In 2002, Honduras had an installed generation farm investment. Administrative approval capacity of 1,073 MW; that year, hydropower procedures were rationalized, and the issue of generators accounted for 39 percent of power. municipal tax payment was resolved (under The country has five State-owned and three Decree 103-2003). private Small Hydropower (SHP) Plants in operation; 15 new SHP projects, totaling 105 MW, The Natural Resources and Environment are under development by private developers. Secretariat (SERNA) is responsible for the The government of Honduras intends to change development, coordination, evaluation, and the existing legal framework to privatize the implementation of projects related to the protection distribution system. Currently, the National Electric and use of water and RE resources. SERNA issues Power Company (ENEE), the vertically integrated, licenses to hydropower and wind energy projects State-owned public company, runs the system. But and implemented micro-hydro and PV projects to the new law proposing an open generation market electrify isolated communities. has not yet been approved. One success factor for private hydropower Reform of the Honduras power sector began in development was development of the Canadian 1994, with the Electricity Subsector Framework International Development Agency (CIDA)- Law and its subsequent regulations in 1998. The supported Power System Master Plan in the early law established that the PPA price for electricity 90s. Before that time, the energy sector was between an IPP and ENEE had to equal ENEE's fragmented by studies and site inventories. short-term marginal power cost. Currently, all private hydropower developers select their sites in accordance with the Master Plan. From 1998 to 2004, additional RE generation- investment incentives were introduced. Renewable In October 2003, the Central American Bank for generating plants below 5 MW and hydropower Economic Integration (BCIE) announced that it plants contributing to flood control (and thereby will cofinance a new hydropower plant with a contributing to watershed management) were paid 12.2 MW capacity. Electricity will be sold to ENEE 10 percent on top of the short-term marginal cost over a 15-year period. The project includes of power. Investors were exempted from management of the 115 square kilometer (km2) paying sales tax on equipment, materials and Río Cuyamapa watershed. At the same time, lack accessories during construction and import duties of progress in attracting private capital to on equipment and accessories during study hydropower led the government to develop the and construction (under Decrees 95-1998 and Special Executive Commission for Hydropower 267-1998). Investors were also exempted from Development Projects that same year. Under the net income tax for five years after starting European Union-financed Autonomous Generation commercial operations. Electricity generated in and Rational Use of Energy Power in Honduras 88 Annex 3: International Experience with RE Frameworks (GAUREE) project, ENEE identified potential Facility [GEF]). In addition, COPE has set up the project sites for which it had prepared National Energy Information and Documentation prefeasibility and feasibility studies. One of these, System (SNIDE); prepared a perspective study the 100 MW Piedras Amarillas Project, was to be for future power supply, including RE; and put up for tender in 2004. developed the National Rural Electrification Plan (PLANER), financed by the Inter-American Panama Development Bank (IDB), which aims to increase national electrification from 81 to In 2002, Panama's installed power capacity 95 percent within 10 years. was 1,533 MW. That year, RE accounted for 65 percent of the national generation, of which all In 2004, COPE issued its policy and criteria for but 0.1 percent (biomass-based cogeneration) was expanding the interconnected power system. derived from hydropower. It concluded that the most financially viable hydropower projects should be included in The 1997 Regulatory and Institutional Framework investment plans to reduce the effect of for Public Electricity Service Law (No. 6-1997) fluctuating oil prices. Specific policy guidelines created the Energy Policy Commission (COPE) as were issued for hydropower and wind energy the power sector's key policymaking institution (Resolutions Nos. 001-2004 and 002-2004). (including RE promotion). Article 55 mentions A major change was introduction of a postage- specifically that it is in the State's interest to stamp transmission charge. promote RE in order to diversify energy supply, reduce environmental harm and lessen Country Lessons for Nicaragua dependency on imported sources. To this end, the law's implementing regulations give RE generation Like Nicaragua, the other four Central American sources a 5 percent price preference when countries that implemented power sector reform ­ distribution companies make their tender calls for El Salvador, Guatemala, Honduras and Panama ­ capacity and energy. Calls for tender rules and have experienced similar problems. All five regulations contain other provisions that favor RE, countries have witnessed the reality that the most important of which is the potential to liberalization favors power sector investments with engage in long-term PPAs (10 years, with a short payback periods, while such capital-intensive four-year waiting period to allow for construction). investments as hydropower and geothermal energy are stymied. In their generation portfolios, The Environment Law reconfirms that natural all five have clearly expressed their preference for resources are State property. It assigns the RE for reasons related to the environment, foreign National Environment Authority (ANAM) exchange and long-term price stability. All have responsibility for setting tariffs on natural resource lamented that private sector RE investments have use, based on the justification provided by been delayed, yet none have imposed a economic and financial studies. moratorium on conventional thermal power investment. All have had difficulty obtaining COPE has implemented a series of RE studies in parliamentary approval of their respective water hydropower (supported by the Electric Power laws. Their RE-promotion strategies have included Transmission Company, SA [ETESA]), geothermal State-financed resource surveys and easing of energy (assisted by ETESA and the International administrative procedures and economic Atomic Energy Agency [IAEA]), and wind energy investment incentives (for example, exoneration of (in cooperation with the Global Environment VAT and import duties, long-term tax holidays 89 Special Report Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua and reduced municipal taxes). None have Obviously, Costa Rica's experience stands apart royalty payment policies for use of water or from that of its Central American neighbors. geothermal resources. Although Costa Rica actively encourages IPP investments, it maintains, through its ownership Some countries are attempting to tilt the tender of ICE, State control over the entire vertical process in favor of RE, for example, by offering chain, from generation to distribution. On the renewable generators a 5 percent price premium. Special offers are being developed for investments demand-side, the advantage is that IPPs can in plants below 5 MW, and special regulations are obtain long-term PPAs. On the supply-side, being adopted for wind farm implementation. All when private IPPs are unwilling to invest in five countries are struggling to introduce long-term hydropower plants, ICE can take on such PPAs into their competitive power environment. investments, as long as the companies are One is considering setting up a specialized retailer sufficiently creditworthy. for this purpose. 90 Special Report Series Region/Country Activity/Report Title Date Number ENERGY AND POVERTY THEMATIC AREA East Asia and Pacific (EAP) Household Energy, Indoor Air Pollution and Health: A Multisectoral Intervention Program in Rural China 06/07 (002/07) RENEWABLE ENERGY THEMATIC AREA Global (GLB) Risk Assessment Methods for Power Utility Planning 03/07 (001/07) Latin America and the Caribbean Region (LCR) Unlocking Potential, Reducing Risk: Renewable Energy Policies For Nicaragua 08/07 (003/07) 91 Energy Sector Management Assistance Program Purpose The Energy Sector Management Assistance Program (ESMAP) is a global technical assistance partnership administered by the World Bank since 1983 and sponsored by bilateral donors. ESMAP's mission is to promote the role of energy in poverty reduction and economic growth in an environmentally responsible manner. Its work applies to low-income, emerging, and transition economies and contributes to the achievement of internationally agreed development goals through knowledge products such as free technical assistance;specificstudies;advisoryservices;pilotprojects;knowledgegenerationanddissemination;training, workshops, and seminars; conferences and round-tables; and publications. The Program focuses on four key thematic areas: energy security, renewable energy, energy poverty, and market efficiency and governance. Governance and Operations ESMAP is governed by a Consultative Group (CG) composed of representatives of the World Bank, other donors, and development experts from regions that benefit from ESMAP assistance. The ESMAP CG is chaired by a World Bank Vice-President and advised by a Technical Advisory Group of independent energy experts that reviews the Program's strategic agenda, work plan, and achievements. ESMAP relies on a cadre of engineers, energy planners, and economists from the World Bank, and from the energy and development community at large, to conduct its activities. Funding ESMAP is a knowledge partnership supported by the World Bank and official donors from Belgium, Canada, Denmark, Finland, France, Germany, Iceland, the Netherlands, Norway, Sweden, Switzerland, United Kingdom, United Nations Foundation, and the United States Department of State. It has also enjoyed the support of private donors as well as in-kind support from a number of partners in the energy and development community. Further Information Please visit www.esmap.org or contact ESMAP via email (esmap@worldbank.org) or mail at: ESMAP c/o Energy, Transport and Water Department The World Bank Group 1818 H Street, NW Washington, DC 20433, USA Tel.: 202.458.2321 Fax: 202.522.3018 RENEWABLE ENERGY Moving into a world with less carbon emissions, better energy security through a more diversified energy supply, and increased availability of energy in unserved areas, in particular where the poorest people live. ESMAP supports renewable energy with advice on policy formulation and development incentives adapted to local conditions. The program assists in design of renewable energy projects suitable for financing by bilateral assistance, Energy Sector Management Assistance Program 1818 H Street, NW international institutions, or the Washington, DC 20433 USA private sector. Tel: 1.202.458.2321 Fax: 1.202.522.3018 Internet: www.esmap.org Email: esmap@worldbank.org The analytical work of ESMAP includes legal and regulatory frameworks for renewables, efficient integration of distributed generation in electrical power systems, and better energy access for remote and poor communities. ESMAP is a knowledge clearing house for good practice and opportunities for renewable energy ranging from large scale electricity generation to biomass serving household heating and cooking needs.