Rural Electri cation

Solar in Mindanao A Social Business Model

Global Environmental Markets Spring 2012

Team Members: Danielle Carille Lindsey Clark Esperanza Garcia Sarah Fackler Erin A. McNally Stefano Vrespa

Rural Electri cation

Solar in Mindanao A Social Business Model

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Social business
A new kind of capitalism

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Clean Development Mechanism

Environmental market power

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On-Grid, O-Grid Financial Model

How to make a nancially sustainable social business.

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Risks and Mitigations Conclusions

Leading business innovation

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Sources

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Rural Electri cation

Solar in Mindanao A Social Business Model
e following is an investment proposal for GE to invest in the construction of solar plants to meet unmet demand of both on-grid and o-grid electricity customers in the Philippines. Energy and energy infrastructure is at the core of GEs success
Solar energy is the most potential

as a multinational corporation and GEs history in the and appropriate solution to the power Philippines dates back to the 1890s, which puts the company crisis in the island. in a prime position to participate in the projected growth of the countrys electricity market. e power problem in Mindanao, one of the three main islands in the Philippines, has been neglected for years, and today, the region suers from a 160 MW power de cit where residents experience power outages of at least two hours a day. In addition, the current energy grid reaches only 82% of the 94 million people in the Philippines. Demand for power in Mindanao is projected to increase for the foreseeable future and as such is considered the fastest growing energy market in all of Southeast Asia. Despite this, no signi cant power-generating capacities are expected to be added to the grid within the next two to three years. is important yet unaddressed problem presents a tremendous opportunity for GE to undertake a form of social business that oers solutions for these issues. e proposed social business model will achieve the dual bene t of gaining rst mover advantages in the renewable energy market in the Philippines and participating in the international carbon oset market.
Senator Edgardo Angara

is investment is strategically relevant for GE and its Southeast Asian operations since the Philippines has committed to an ambitious renewable energy target of 50% under its Renewable Energy Act by 2030. is Act is highly championed by experts as the best renewable energy law crafted in Asia, and the total additional power requirements are expected to rise to a new capacity of 4,100 MW by 2017. With increasing energy demand and a skyrocketing cost of electricity (power cost in the Philippines is 75% more than Koreas $0.08/kWh, 100% more than Malaysias $0.07/kWh, and 180% more than Taiwans $0.05/kWh), the Philippines has recognized that it is crucial to invest in and welcome foreign investment in the development of renewable energy initiatives. Solar power plants could be deployed in a matter of months instead of the years it would take to build a conventional fossil fuel plant. Along with the minimal impact of solar on the electricity rate, we believe that solar is the best option to help address the above issues. GE a corporation that has always been at the forefront of the worldwide energy market should take advantage of the opportunity to enter the growing local Philippines electricity market as well as the international environmental carbon oset market by implementing an innovative social business model.

Social business
A new kind of capitalism
e proposed project embraces the idea of social business as pioneered by professor Muhammad Yunus. is type of business model is a non-loss, non-dividend model devoted to solving both a social and an environmental problem that have been identi ed in the Philippines: the need to electrify o-grid rural barangays and reduce greenhouse gas emissions by transitioning to renewable energy sources. To achieve this, our model entails the construction of two 5 MW on-grid power plants on the island of Mindanao to confront unmet energy demand that will otherwise be met with fossil fuel generation. e projects pro ts will be reinvested in rural electri cation through the construction of small o-grid micro scale plants. A social business must be self-sustaining, and hence all pro ts from power generation and environmental market participation from both on-grid and o-grid plants will be used to build additional o-grid plants. e structure of the model provides a unique opportunity to identify and engage GE investors who are interested in social investment and willing to recoup only their initial investment with no receipt of dividends. e project also has the potential to be a partnership with GE Foundation. e project will also allow us to generate certi cates through the UNFCCCs Clean Development Mechanism (CDM), which will be discussed in the following section. e sale of these certi cates will have a signi cant impact on the scope of this project and will help us break into the international environmental market place.

Clean Development Mechanism

Environmental market power
e Clean Development Mechanism emerged from the Kyoto Protocol in 2007 as the new option to facilitate investment in climate change mitigating projects. It is intended to meet two objectives: (1) to assist non-Annex I countries in achieving sustainable development and (2) to assist Annex I countries in achieving compliance with their emission reduction goals and targets through Certi ed Emission Reductions credits (CERs). ese credits can be generated through participating in a number of quali ed emission reduction projects in developing countries. ese projects, typically including renewable energy, energy eciency, and fuel switching, open new avenues for rural electri cation. Under the classical structure of CDM, projects registration and veri cation is conducted on a project-by-project basis. e high transaction costs, lengthy processing time, and registration risks are all concerns that have been expressed regarding CDM. In addition, the average project size and associated energy market for less developed countries (LDCs), which further increases the relative transaction costs associated with each individual project. ese factors further increase the cost to apply for a CDM project under the classical structure and as such, the CDM Executive Board launched a Programme of Activities methodology also known as Programmatic CDM to expand the applicability and reduce the transaction costs. is is achieved by allowing a Managing Entity to de ne broad parameters for a group of similar CDM project activities that are included under one umbrella the Program of Activities and thus requiring only one registration as a CDM project.

is type of CDM would provide the nancial incentives necessary to make our individual projects cost eective, as well as provide the exibility necessary to add individual rural electri cation plants year after year. Just as with traditional CDM, the projects need to prove that the generated carbon emission reductions are additional and would not have occurred under a business as usual scenario. e certi cates are only realized through the projects existence, so GE will continuously accrue CERs over the life of the social business. To determine additionality, we used the benchmark approach to establish our baseline emissions. As required by the CDM, each project must use an approved methodology to determine existing pre-project emissions and monitor ongoing emissions once the project is up and running. For the on-grid consumers we used, as a baseline scenario, a 300 MW coal power plant recently endorsed by the Davao City Council. In determining the o-grid baseline, we used the rural electri cation methodology. is methodology outlines several requirements, such as 75% of consumers have to be households and each project has to be less than 15 MW total, and is based on the number of facilities electri ed, the given emission factor and the total number of solar plants installed. e primary market uncertainty lies in the Philippines designation as an LDC: due to the current Philippines GDP growth rate its possible that in the next few years the country will no longer be listed as an LDC. As long as the Programmatic CDM is approved by the CDM Executive Board while the Philippines is still considered an LDC, any projects under the PoA that are constructed after any potential country designation change will still be eligible to generate CERs. erefore, in order for this project to qualify under CDM as it has been proposed, the Program of Activities would need to be registered by the Managing Entity, aka GE, before the end of the year.

On-Grid, O-Grid Financial Model

How to make a nancially sustainable social business.
A cash- ow analysis has been conducted to evaluate the feasibility of the social business model proposed and, thus estimate the potential impact of the project on the electri cation rate of the rural o-grid barangays. e nancial model includes two dierent systems: the two on-grid 5 MW solar power plants; and multiple 100 kW o-grid solar systems each supplying one barangay. All nancial assumptions for both on-grid and o-grid projects, for as long as the solar plants operational life (20 years), can be found in the tables on page 10. e on-grid system e cost per MW installed is assumed to be roughly equal to $3.5 million (including hard costs, soft costs and yearly O&M). e main revenue stream is generated from the on-grid electricity sales at the price of $0.52/ kWh(1, 2), which includes the feed in tari ($0.34/kWh), a policy mechanism that is employed under the Philippines Renewable Energy Act to accelerate investment in renewable energy technologies. is is achieved through the oering of long-term contracts to renewable energy producers at a preferential price. As a CDM project, additional income will be generated through the sales of Certi ed Emission Reductions (CERs). e amount of avoided emissions is calculated assuming the solar system will oset emissions from a new coal plant, which has been approved for the Davao region (3). e following assumptions were used: average grams of CO2 equivalents emitted per kWh generated (900g CO2 equiv./ kWh) (4), CER oor price of ~$5 (5).

e o-grid system Using the information provided by the Philippine Solar Power Alliance the average number of households per barangay (200) and the maximum daily electricity consumption (3 kWh/day) we were able to determine the o-grid system capacity, its cost, and the average amount of electricity
On-grid data number of power plant Plant size (GE) capacity factor kWh produced hours CER price ($) Coal plant average CO2 em. Avoided emissions Min CER Revenue Cost per plant Total cost CDM Approval Cost Operating Cost Average national price FIT tarif Degression Rate Annual Growth in Price income tax 2 5 20% 17,520,000 8760 5.14 900 15768 81,093 (16,190,373.93) (32,380,747.87) (40,000.00) (1,019,971.65) 0.18 0.34 6% 4% 32% MW kWh/Year $ g/kwh Tons CO2 eq/year $

dispatched per household (2.4 kWh/day). To further foster the number of o-grid systems installed, we considered two additional revenues. e rst is generated by the sale of electricity to the rural households at a rate 50% lower than the current market price ($0.09/kWh). is income will cover the O&M expenses for each o-grid system. e second source of revenue will be generated upon the recognition of the o-grid project as a programmatic CDM and upon the likelihood of selling CER credits on the European market at a

$ $ $ $ $ $

price at least equal to the price oor previously identi ed. To quantify this extra source of revenue we determined the total amount of CO2e displaced with the UNFCCC methodology: Electri cation of rural communities using renewable energy. (6) Since the cost of the o-grid system is assumed to be proportional to the per MW cost of the on-grid system, the total number of o-grid systems to be constructed is determined by the overall net income that can be reinvested in rural electri cation.
Off-grid data average energy provided per household 2.4 average barangay 200 Plant size (GE) 100 capacity factor 20% hours 8760 kWh produced 175200 CER price 3.6 CER price ($) 5.14 Cost per plant $ (323,807.48) Operating Cost $ (10,199.72) CDM Approval Cost $ (15,000.00) Average national price $ 0.18 Price $ 0.09 FIT tarif $ Annual Growth in Price 4% income tax 32% Cost per household/year $ 78.84 KWh/day/household households Kw

KWh/year euro $

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Combined Model Other major assumptions that drove the overall nancial results are: straight-line depreciation for the on-grid and o-grid system and a 7 year tax exemption for the on-grid power plants under the Philippines Renewable Energy Act/ NREB (7). e signi cant impact that the tax exemption has on our net income is apparent in Figure 1 where the trough of o-grid plants is found when the tax exemption is over in 2020. We also factored in the full repayment of the ~$32 million in principal received from investors over the 20 year life of the project with no interest or dividends. e cash- ow and NPV analysis was conducted over 20 years at which point the on-grid plants would no longer be in operation. ree dierent scenarios were considered to comprehensively evaluate the impact of the overall project on the social and environmental issues previously identi ed. ese scenarios dier in the amount of retained earnings for on-grid reinvestment at the end of the 20 years: (1) no on-grid reinvestment, (2) replacement of 1 on-grid plant or (3) replacement of both on-grid power plants. In all scenarios we broke even and the project was economically viable. We included the rst scenario to try to evaluate the maximum potential impact on the rural electri cation rate. is case assumes that at the end of the 20-year lifespan of the on-grid plants, all of the barangays will be connected to the grid and the social business as we initially conceived wont be necessary anymore. At this point, the parameters and goals of the social business would either be adjusted and re-evaluated or GE could decide to shift their focus to a for-pro t renewable energy business. We suggest pursuing the rst scenario to foster GEs position into the Southeast Asian energy market as the leading socially responsible company by helping to improve the electri cation rate of the Philippines. is will help us gain a privileged position in the marketplace to ensure a future for-pro t position in a country that is well on its way to becoming a developed country.

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160.00

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140.00

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120.00 10

Total O -Grid Plants

100.00 8 80.00 6 60.00 4 40.00

New O -Grid Plants

O -Grid, 1 plant r. O -Grid, 2 plants r. O -Grid, no reinv. New O -Grid plants

20.00

0.00 2010

2015

2020

2025

2030

0 2035

Figure 1: o-grid systems installed per year and overall trend

20000

18000

16000

14000

Tonnes of CO2 eq. avoided

12000

O -Grid, no reinv.
10000

On-Grid O -Grid, 1 plant r. O -Grid, 2 plants r.

8000

6000

4000

2000

0 2010

2015

2020

2025

2030

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Figure 2: Tons of CO2 equiv. avoided under dierent scenarios for the on-grid and o-grid
40000

35000

Total Tonnes of CO2 eq. avoided

30000

On-Grid
25000

O -Grid, no reinv. O -Grid, 1 plant r. O -Grid, 2 plants r.

20000

15000

10000 2010

2015

2020

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2030

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Figure 3: Total Tons of CO2 equiv. avoided under dierent scenarios.

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Risks and Mitigations

Risk Assessment In addition to the various uncertainties that may aect the accuracy of our nancial model, a diversity of risks associated with investing in the CDM market and installing both o-grid and ongrid solar power plants in Mindanao exist. e CDM-speci c risks address licensing and regulatory, political, as well as market and nancial considerations; while project speci c risks address environmental, climate change, as well as operations and management considerations. CDM-Speci c Risks Licensing and regulatory risks are associated with every stage of a CDM project. e greatest risk to the viability of our project is the potential to not gain approval late within the project cycle. is can happen even after a contract for the sale of CERs has been entered, and will result in the loss of transaction costs. e risk of project delay is also common to the registration phase, as baseline methodologies must often be revised. Due to the lack of a concrete system for years after 2012, the allocation of CERs may be reduced at any time. In this sense, the 21-year crediting period of our project presents an additional challenge. Political risks encompass those concerning the control of the Philippine government. ese may include: failure to obtain national approval for CDM, regulatory changes in economic and energyrelated policies related the baseline of the project, or the introduction of a feed-in-tari or CER tax. e myriad of risks associated with the CDM market is largely due to its immaturity, and resulting price uncertainties. For example, the future market price may substantially increase relative to the contract price at any time, but it is expected that this uncertainty will decrease as market liquidity increases. Further nancial risk presents itself in the use of local currency for sale of CERs, which is especially high for the Philippines due to the recent depreciation of the peso. Finally, the uncertainty of the Philippines status as an LDC country threatens the viability of the entire project, as it may soon no longer be able to apply for CDM status. Project-Speci c Risks e predominant environmental risk to the installation of a solar power plant is that of insucient sunlight. While our model assumes only 20% generation for baseline calculations, the seasonal dierence in cloud cover and related solar insolation during the monsoonal (wet) and dry seasons is

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substantial. Additional environmental risks include a variety of natural hazards, such as earthquakes, landslides, tropical cyclones, oods, and droughts. Climate change projections indicate an increase in extreme weather events by the end of the century, which will likely amplify the risks associated with these natural hazards and climatic phenomenon. However, a reduction in rainfall is projected for Mindanao by the end of the century, which will reduce the risk concerning insucient sunlight. Similar risks present themselves during the operations and management phase. Primarily, this includes the underperformance of the solar technology that may reduce potential gains. Solar project specialists in the Philippines have additionally conveyed to us the common occurrence of solar panel theft for rural electrification projects as well as the risks associated with returning to the project site as battery replacement is necessary every 1,000 watt-hours. The majority of these risks would be inherent to any foreign investment projects in new markets that involve a great number parties and remote location. Best risk mitigation practices will involve investing in and communicating with the local communities in order to incentivize cooperation and spread knowledge and technology transfer. Risk Mitigation Further risk mitigation will focus on four areas: 1) Due Diligence, 2) Contract Negotiation, 3) O&M and Safety Plans, 4) Insurance. Use of these strategies will maximize the chances for a strong return on investment. Due Diligence Due diligence will focus on upfront research, particularly in in terms of weather variability, local geology, accessibility of our project location to the grid, and local culture. is will ensure the projects success and allow us to recoup our initial investment while avoiding unexpected future costs.

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Contract Negotiations orough contract negotiation will allow the sharing of business risks with associated partners. Such contracts include power purchase agreements, CDM, Feed-in Taris, and construction contracts. is will focus on negotiating indemnity clauses and requiring partner parties to possess high levels of insurance. e cost of negotiating contracts however, must be reduced to a minimum as legal costs and fees can be substantial. Such negotiations also pose the risk of delay for project implementation if not completed in a timely manner. is may be mitigated by setting strict deadlines within an action plan. O&M and Safety Plans Creating detailed operations and management (O&M) and safety plans will minimize the majority of risks presented during the construction and O&M phases. ese documents will enable us to educate the local workforce on safe construction and operation procedures, as well as allow us to reduce the costs of insurance. Insurance Purchasing insurance is one of the most common ways for business entities to reduce risk. During the construction and operation phase of our project, the purchase of sucient insurance such as Builders Risk/Delay in Startup, Property, Construction Liability, Operational Liability, and Environmental Liability, will be crucial. Depending on cost, a combination of warranty insurance, weather derivates, and political risk insurance should also be purchased. Warranty insurance for solar panels will provide an additional layer of protection against any equipment failure and technology underperformance. e risk of insucient sunlight may be mitigated with weather derivatives. Lastly, political insurance will reduce the many risks associated with environmental markets. Speci cally, it may help reduce exposure to feed-in taris and the CDM market.

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Conclusions
Leading business innovation
Other multinational companies, including Danone and BASF, have engaged in social businesses that address identi ed social and environmental problems by creating a solution based on their core business. Energy and energy infrastructure are at the core of GEs success as a multinational corporation and they have had a presence in the Philippines since the 1890s. e goal of this project also aligns well with that of our corporate citizenship report and will further propel us into a leadership role in the realm of corporate sustainability. As with any project, there are risks involved and in this analysis we have identi ed various methods to hedge against the full scope of risks posed by this type of project. GEs size and expertise in energy and nancial markets is sucient to participate in the relatively new CDM market as well as the risk mitigation activities we have proposed. Partaking in this social business model would put GE at the forefront of an innovative method of contributing to sustainable development while serving as a pilot project for our environmental markets strategy. is model represents an opportunity for GE to realize rst mover advantages in one of the fastest growing energy markets in Southeast Asia. After a few meetings held with on-theground Filipino solar advocates, it became clear that in order to ensure a successful, long-term business in the Philippines it is essential to gain the trust and loyalty of the people and politicians. Delivering inexpensive energy to poor rural citizens and contributing to the goals of the governments renewable energy plan will garner these essential relationships. is strategic move will put us in a position to be the top supplier of solar in the electricity market as more barangays are brought onto the national grid and overall energy demand increases.

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Sources
1. Senate Economic Planning Oce Electric power at a glance, 2005 http:// www.senate.gov.ph/publications/AG%202005-07%20-%20Electric%20Power.pdf 2. National Renewable Energy Board Status of the RE Mechanisms, Sharing Experiences on RE Promotion February 2012 http://eeas.europa.eu/delegations/philippines/documents/ press_corner/renewable_energy_mechanisms_maniego_en.pdf 3. Edith Regalado Philstar news 27 October 2011 http://www.philstar.com/nation/ article.aspx?publicationsubcategoryid=67&articleid=741618 4. Marion, Nsakala, Grin, Bill Controlling Power Plant CO2 emissions: a long range view http://www.netl.doe.gov/publications/proceedings/01/carbon_seq/1b2.pdf 5. http://www.eex.com/en/Market%20Data/Trading%20Data/Emission%20Rights/Certi ed %20Emission%20Reductions%20Futures%20%7C%20Derivatives/Contract%20Information/ futures-info/F2CR/2012.12 6. UNFCCC CDM Executive Board Indicative simpli ed baseline and monitoring methodologies for selected small-scale CDM project activity categories, Electri cation of rural communities using renewable energy Revision 01.0 2 March 2012 7. National Renewable Energy Board Status of the RE Mechanisms, Sharing Experiences on RE Promotion February 2012 http://eeas.europa.eu/delegations/philippines/documents/ press_corner/renewable_energy_mechanisms_maniego_en.pdf

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