No. 12 KNOWLEDGE EXCHANGE SERIES January 2009 Easing Investment Barriers: 48646 Nicaragua's Renewable Energy Potential by Wolfgang Mostert Today Nicaragua's economy faces a triple squeeze: high power prices, power shortages, and increased costs for imported fuels. Despite the country's economically-viable renewable energy (RE) potential, risk-averse private investors prefer diesel power plants, with their low upfront costs. This note highlights lessons from the country's failed power-sector reform of 1998­99 and recent measures to ease barriers to RE investment.1 Renewable Energy: Untapped Potential Nicaragua, CentralAmerica's largest country (129,500 sq km), is endowed with abundant, high-quality re- El Bote, a 930-kW hydropower project located in Nica- newable energy (RE) resources. In 2004, the country's ragua's central highlands, delivers power to 2,700 rural residents. economically-viable RE potential was 3,000 mega- watts (MW)--five times its national power capacity-- Despite RE's rich potential and price competitiveness, composed of hydropower (1,700 MW), geothermal available RE capacity in 2006 amounted to only 243 (1,000 MW), wind farm (200 MW), and biomass (200 MW: biomass (108 MW), hydropower (98 MW), and MW). Generation at potential RE project sites, spread geothermal (37 MW). From 1980 to 2005, RE's share throughout the country, is highly price-competitive in national power production fell 25 percent (60 to compared to conventional thermal power.2 35 percent), while investment in diesel-fired power New geothermal and hydropower plants and wind continued to rise. Political issues, along with low per farms offer an array of potential advantages: capita income, acted as constraints.3 Investment in infrastructure stagnated; by 2005, 1.7 million residents Supplying additional power at a lower risk- were still without electricity. Today's daily power out- adjusted cost per kilowatt hour than conven- ages are a reminder that power-sector reform failed tional thermal plants, to bring sufficient private capital into generation to Saving foreign exchange, achieve a more rational portfolio of power projects. Generating employment, Why Reform Failed Increasing national value added, and The objectives of Nicaragua's 1998­99 power-sector reform were threefold: Providing price stability. Develop the country's economic RE potential In addition, the capital requirements for RE invest- for generation, ments offer an opportunity to accelerate the develop- ment of a national capital market. Reduce high system losses in distribution, and Increase the national rate of electrification. 1This note is based on the 2007 ESMAP report, Unlocking Potential, Reducing Risk: Renewable Energy Policies for Nicaragua. Building on the findings of studies supported by Nicaragua's National En- Like other Central American countries that under- ergy Commission and ESMAP, the author proposes a comprehen- went power-sector reform in the late 1990s--El Salva- sive strategy for promoting RE investment in Nicaragua. dor, Guatemala, Honduras, and Panama--Nicaragua 2 To be financially viable, Nicaragua's geothermal power proj- implemented a vertical breakup of its power sector, ects require US$65­70 per megawatt hour (MWh) (GPS 2006). privatizing its generation and distribution assets. At The financial production costs of several potential hydropower plants are estimated at less than US$60 per MWh (Scheutzlich 2004). Wind energy at the better sites requires US$60­66 per MWh 3About 70 percent of Nicaragua's population of 5.5 million-- (Jiménez and Povedano 2003). In 2005, the average price for bulk 77 percent of dispersed rural residents and 64 percent of urban thermal power was US$88 per MWh. dwellers--live in conditions of poverty. ESMAP Knowledge Exchange Series No. 12 1 5869-Book.pdf 1 1/28/09 11:24:58 AM KNOWLEDGE EXCHANGE SERIES January 2009 thattime,thecostofinvestmentcapitalwashigh,while Box 1. Market Rules Bias international prices of oil and coal were low. None Before Nicaragua adopted the 2005 Renewable En- of the five countries imposed restrictions on private ergy Promotion Law, wind farms and run-of-the-river investment in generation; in each case, market liberal- hydropower plants were not entitled to a capacity izationledrisk-averseprivateinvestorstoavoidcapital- payment on the contracts market or the short-term intensiveREtechnologies,preferringconventionalther- capacity market, which is settled daily. The price dif- mal power plants. As a result, RE share declined.4 ference is substantial. Between November 2000 and June 2003, energy prices were US$34­59 per MWh ver- Lack of facilitating rules. Rather than establishing sus US$60­71 per MWh for the monomial price,* which enabling conditions for developing the country's includes the cost of capacity payments. Generators' obligation to provide a capacity reserve equal to RE potential, the designers of Nicaragua's market 5 percent of installed capacity imposed a greater fi- scheme focused on creating a competitive power nancial burden on wind farms, which have a lower ca- pool in a market characterized by an oligopolistic pacityfactorthanthermalpowerplants;thatis,persold structure on the supply side and a monopsony on the kilowatt hour, the cost of that obligation is higher. Thus, although Nicaragua has some of the world's best wind- demand side. But with no specific facilitating rules, farm sites, market rules have rendered the commercial power pools have been biased against investment viability of wind-farm projects virtually impossible. in RE generation. Short-term selling into a market with fluctuating power prices has increased revenue * Average price of PPA contracts and spot markets, which yields the bulk power market's kilowatt price that the distribu- uncertainty, driving up the cost of capital and un- tor, Union Fenosa, is allowed to pass on to final consumers via dermining the cost-competitiveness of investing in its tariffs. capital-intensive RE power plants. Bulk-power market rules have not favored conclud- eliminate. The Nicaraguan government did not ing long-term power purchase agreements (PPAs). establish a facilitating framework that would have In addition, the price evaluation method for PPA made theft a criminal offense and would have put tenders, implemented by Union Fenosa, the Span- in place a small-courts procedure. [The electricity ish distribution company, has offered no premium law criminalizing electricity theft was finally passed for price-risk differences between fixed-price of- in 2008.] Prevented by the regulator from including fers from RE generators and tariff bids from diesel full coverage of system losses in its tariffs, Union power plants, which have automatic adjustments for Fenosa slid into a precarious financial position; in changes in imported fuel prices. Furthermore, mar- turn, investors ready to sign long-term PPAs with the ket rules have undermined the financial viability of distributor found it difficult to secure project finance. intermittent sources of power supply (box 1). In short, Union Fenosa was not a creditworthy off- Poor policy sequencing. Market liberalization was taker of power (Barnes and Waddle 2004). introduced before key legislation allowing developers Blocked legislation. Political divisiveness and a regu- to access potential RE project sites had been adopted. latory setup of competing institutions with overlap- At the time of power-sector restructuring, a critical water rights law had not been passed, leading to the failed privatization of HIDROGESA, the state-owned hydropower holding company and, more impor- tantly, the inability to develop larger plants. Also, development of geothermal power generation was blocked by legislation that converted resource-rich areas into national parks (GPS 2006). Distributor Union Fenosa, which won the two ten- dered concessions, was unable to reduce inherited system losses--more than 35 percent--to the lower levels prescribed in its regulatory contract. Toler- ance regarding electricity theft proved difficult to 4Costa Rica, which did not undergo reform, required indepen- In Nicaragua's remote Atlantic Zone, 350 families benefit dent power producers to invest solely in RE generation projects; from 2-kW capacity, solar battery charging stations in- by 2003, RE share had reached 98 percent. stalled by the Offgrid Rural Electrification Project (PERZA). 2 ESMAP Knowledge Exchange Series No. 12 5869-Book.pdf 2 1/28/09 11:25:03 AM A long-term "green bonus" imposed by an RE portfolio scheme, paid on top of the pool market price. Easing Barriers to Investment International experience shows that two factors are critical to the success of any national RE policy: Acomprehensive regulatory framework tailored to the needs of RE power generation and Adoption of published, quantified targets by specified years for RE power-market penetration. Nicaragua's 1998­99 reform process failed on both counts; by the end of 2002, RE share in total power gen- Photovoltaics workshop sponsored by the Offgrid Rural Electrification Project (PERZA). eration had fallen to 23 percent, the lowest in Central America.Thepost-reformyearsof2000­04witnessedthe ping responsibilities blocked legislation promoting issuance of various presidential decrees that provided RE investment. The power-sector reform process generous incentives for RE investment and guaranteed divided governance functions between the National market access for wind-farm and hydropower projects Energy Commission and the National Energy Insti- up to 5 MW.Yet general market and political uncertain- tute. The National Energy Commission was made re- ties rendered these incentives ineffectual. By late 2005, sponsible for energy planning, laws, and regulations; thehighpricesofimportedfuelsrevealedthemacroeco- preparation of national and rural expansion; and nomic and social costs of inadequate RE policies. implementation of rural electrification projects. The In response, the national assembly adopted three laws National Energy Institute was to handle sector regula- built on earlier policy efforts by the National Energy tion. From the outset, disagreement between the two Commission (box 2). Adoption of these laws reflects institutions on critical issues hindered development a lessening of the political divisions that have long of a coherent approach to rural electrification and RE policy. By 2006, with the supporting institutional and Box 2. Toward a Virtuous Cycle of RE Investment: financial framework for accelerating rural electrifica- Laws Adopted in 2005 tion still undecided, the National Energy Commission Energy Service Stability Act (No. 554-05): adopted a project-by-project approach. Introduced a series of short-term emergency In 2005, a political power struggle between the execu- measures and made electricity theft illegal. tive and legislative branches of government climaxed Amendment to the Hydropower Promotion Law when, by act of parliament, the National Energy Insti- (No. 531-05): tute was replaced by the Superintendency of Public Authorized the Ministry of Development, Indus- Services, a multisector regulator, and the president try, and Commerce to grant run-of-the-river hy- declared the nomination of regulators an unconstitu- dropower plants water rights of up to 30 MW af- tional encroachment on executive powers. Paralysis of ter consultation with pertinent local authorities. the regulatory agencies' work ensued, creating further Renewable Energy Promotion Law (No. 532-05): uncertainty for potential RE investors. Exonerated projects from paying import duties Lessons in Power Market Design and value-added tax on equipment, income tax for 7 years from project start-up, municipal To achieve financial closure, geothermal, hydropower, turnover and property taxes for 10 years, and and wind energy projects usually require one of the natural resource taxes for 5 years. following: Introduced grid feed-in tariffs for wind-farm and run-of-the-river hydropower projects up to 5 MW A long-term PPA with a credible off-taker; (valid for 12 years in a range of US$55­65 per Guaranteed market access through a fixed, feed- MWh, based on a reference rate of US$39 per barrel of crude oil). in tariff for a specified number of years; or ESMAP Knowledge Exchange Series No. 12 3 5869-Book.pdf 3 1/28/09 11:25:08 AM characterized Nicaragua's business and regulatory envi- Conclusion ronment and, in turn, damaged investor confidence.5 Although the legal, regulatory, financing, and institutional The Energy Service Stability Act can help Union Fenosa to framework has much room for improvement, the current reduce non-technical system losses if supplemented by a environment for RE investment is more positive. Still miss- small-courts procedure and political pressure on the police ingarethreemajorpolicyinitiatives:(i)mixed-userulesthat forcetoprioritizetheprosecutionofcases.TheAmendment permittheestablishmentofgeothermalpowerplantsinareas to the Hydropower Promotion Law will enable investors now designated national parks, (ii) adoption of the water to develop small run-of-the-river hydropower plants. The rights law, and (iii) quantitative targets for RE penetration. first plants may become operational within four years. The The Nicaraguan case shows that halfway implemented feed-in-law for mini-hydropower and wind-farm projects reforms carry a high economic cost. While competitive ought to get the first power plants into operation within market schemes offer cost savings, they are never technol- three years, despite the tight international supply situation ogy neutral in a world of uncertainty. When fuel prices are for small wind farms. The economic incentives offered by on the rise, low-investment technologies with high fuel the Renewable Energy Promotion Law will have a limited costs hit the economy, not their investors. In a competitive effect. RE investments are already least cost, and percep- pool, their generators are the marginal price-setting unit. tions regarding the long-term price of hydrocarbon fuels The market design challenge is to identify the portfolio has shifted sharply upward over the last several years. As mix that provides the least-cost supply options for the a risk premium for investing in capital-intensive technolo- country and develop instruments and market rules that gies, the tax incentives are skewed in the sharing of risks: guide private investments toward it. The first 10 years of operation are not counterbalanced by increased public benefits after that period. References Weaknesses in the institutional and regulatory framework Barnes, Douglas F., and Daniel Waddle. 2004. Power-sector Reform and the Rural Poor in Central America. ESMAP Formal Report 297/04. are being addressed. In 2006, the National Energy Com- World Bank, Washington, DC. mission was elevated to ministry status. Elections brought GPS (Global Power Solutions). 2006. Nicaragua: Policy Strategy for the a new parliament and president, which have helped to Promotion of Renewable Energy: Geothermal Energy Component. GPS resolve the constitutional deadlock over the Superinten- final report, ESMAP. World Bank, Washington, DC. dency of Public Services. Jiménez, O., andA. Povedano. 2003. Caso de estudio: Situación y perspectiva de la energía eólica. National Energy Commission and ESMAP. Mostert, Wolfgang. 2007. Unlocking Potential, Reducing Risk: Renew- able Energy Policies for Nicaragua. ESMAP Special Report 003/07. 5 ESMAP-financed studies played a significant role in facilitating an un- World Bank, Washington, DC. derstanding of Nicaragua's institutional limitations and potential sourc- Scheutzlich, Thomas M. 2004. Situation and Perspective of Hydroelectric es of energy, which contributed to national policymakers' formulation Generation (100 kW­25 MW) in Nicaragua. National Energy Com- of energy legislation promoting the use of renewables. mission and ESMAP. ESMAP's Knowledge Exchange Series (KES) shares results of recent energy sector work to catalyze discussion and learning among energy policy makers and practitioners. The KES is produced by the Energy Sector Management Assistance Program, a global knowledge and technical assistance partnership administered by the World Bank and sponsored by bilateral official donors since 1983. ESMAP's mission is to assist clients from low- income, emerging, and transition economies to secure energy requirements for equitable economic growth and poverty reduction in an environmentally sustainable way. About the author: Wolfgang Mostert, an economist and renewable energy specialist, is a World Bank consultant based in Denmark. Douglas F. Barnes, Technical Editor · Norma Adams, Editor · Marjorie K. Araya, Production Photos: Thomas M. Scheutzlich, p. 1; Ernesto Terrado, p. 2; Offgrid Rural Electrification Project (PERZA), p. 3. Copyright © 2009 Printed on recycled paper. Visit us online at www.esmap.org 5869-Book.pdf 4 1/28/09 11:25:12 AM