Coal Tax Follies

Carbon tax is what the doctors prescribed to cure our fossil fuels’ addiction. This works when supplies shift to favor cleaner, affordable, and secure sources of energy. Given the choice and incentives, managers would opt to adopt non-polluting supplies to avoid the penalty.

The prescription fails ab initio when policy misdiagnosed the illness. By ignoring the Philippine peculiarities as an archipelagic power system, how coal tax would hit consumers could only provide a partial view. This is a disservice to applying a theoretically sound prescription (i.e. penalizing polluting technologies) to the wrong illness (i.e. lack of affordable and secure supplies).

Continued access to viable and affordable power supply and poor infrastructure are the real problems. The coal tax hardly addressed these issues. However, it may just achieve to kill the goose (secure power supply) that lays the golden eggs (buoyant economy).

GAS AVAILABILITY ≠ POWER SUPPLIES
The Philippines started with extensive use of hydro and geothermal power, balanced with coal and diesel.

When Malampaya became operational, gas usage grew to account for 22% (2,871 MW) of Luzon’s dependable power supplies (or 13,108 MW), with coal and diesel accounting for half (7,517 MW). Curiously, Visayas (2,498 MW) and Mindanao (2,318 MW) has zero gas usage. Instead, Mindanao opted for diesel before adopting coal belatedly. After experiencing up to 18 hours blackouts by 2011, the logic for balancing hydropower with coal became convincing. Visayas followed by using coal-fired power to meet expanding demand in Iloilo and Cebu. Leyte and Negros’ geothermal supplies complete the power supplies portfolio.

European power markets “progressed” from coal to gas and nuclear, with wind and hydropower selectively gaining traction. In contrast, Philippines “retrogressed” from clean energy to coal — not by choice but by necessity. Pipeline gas requires gas-fired capacity to use the gas it delivers. This requires substantial investment in infrastructure that only the Luzon grid could provide the minimum economic volume. Visayas and Mindanao, in contrast, are far too limited to viably absorb Malampaya’s gas.

Imported gas could substitute for the depleted Malampaya gas by 2025.

To make this happen, a regasification facility should be constructed. The investment is viable at a minimum annual volume of a million tons, enough to fuel 1,000 MW of gas-fired capacity. Luzon is the only viable market to sustain this volume.

Geothermal prospecting yielded mix outcomes, while hydropower experienced similar results.

With all the good intentions, alluring headlines claiming solar power’s competitiveness (vs. coal and gas) failed to convince. At least no long queues are apparent to rush to develop solar farms.

Ironically, short of a massive gas find to replace Malampaya, or regasification facility becoming available, coal-fired power remains among the few viable and affordable sources to secure power supplies for years to come. Geothermal and hydropower could pull their weight to secure our energy supplies if new sites are found soon.

COAL TAX FALLACIES
Carbon taxation succeeds when it is implemented as part of a holistic energy strategy. This takes into account available indigenous resources, energy logistics and grid infrastructures, existence of functional energy markets, and coherent fiscal practices that balance competing interests. Ad hoc and piece meal cherry picking of measures have failed, and continue to inflict enormous harm to consumers and industry.

In my new book, I posit that under functional energy markets, carbon tax applied to ALL polluting technologies could set one periodic price for power. Given this market price signal, managers could decide on how to structure their supply portfolios that best achieve their objectives. That portfolio is influenced by what energy resources are available, and the uncertainties surrounding access, costs, and fuel supplies.

Under integrated and interconnected markets, such as continental Europe and North America, energy and power supplies are fungible. For consumers, they pay for the kWh or molecules of energy that they consume. Managers in turn decide and invest on assets that best satisfy a given demand – usually through a portfolio of supplies that balances risks and returns under dynamic markets.

Renewables’ virtues are embodied in geothermal and hydropower.

Running at 85% to 95% utilization, they compete with coal and gas in terms of costs with the added advantage of zero fuel costs once the resources are found. This is where the twin challenges of the Philippines are manifested: We have to find the resources first — a feat that is proving difficult. The other is sub-optimal efficiency where some assets operate at 65% — a far cry from well-maintained assets’ performance.

Philippine power grids operate as partially connected systems, with Luzon and major Visayan islands functioning as “one system.” In reality, they are constrained by limited interconnection capacity, with Mindanao completely isolated. Implications? We have multiple prices that reflect distortions arising from regulator’s frequent interventions, long-term supply contracts that experience occasional renegotiations, and subsidies divorced from market realities.

A coal tax imposed under Philippines’ archipelagic energy systems could adversely impact coal-dependent Luzon. Accounting for the bulk of the country’s economic activities, Luzon’s decline could arrest the country’s continued economic buoyancy.

What drove Philippines to embrace coal was a classic response to resolving a resource constraint problem. With limited alternatives, the simpler coal and diesel fuel logistics made coal and diesel the fuel of choice for power generation.

By ignoring these realities, a coal tax may inadvertently contribute to the next severe power shortage. If the tax succeeds, investors will be deterred from building new coal-fired power plants. Without regasification facility, gas-fired power supplies could diminish for lack of gas. At this point, the specter of 1986-1994 power outages comes back to haunt us. Renewables on its own are unlikely to replace lost supplies, much less to meet rising demand.

Poor logistics impairs realizing the full benefits of renewables. Visayas is a case in point. Enthused by sunlight’s allure, Negros Island hosts among the largest solar farms in Asia. Sustained by generous feed-in-tariffs (FiT), solar power’s peak outputs at noon exceed the transmission capacity to deliver supplies to Cebu and Iloilo, where the bulk of power demand is. When Negros needs the power at night, the island suffers the occasional “brownouts” in a sea of surplus installed capacity.

CONTRADICTIONS AND CONSEQUENCES
Taking the environmental logic to its (il) logical end, the coal tax should discourage the lock-in on “dirty coal” by decisively shifting to “clean” solar. Two contradictions are apparent:

Advocates tout Meralco’s contract at P2.99/kWh with Solar Philippines as proof of solar power’s viability. However, solar power’s “success” argues for elimination of all forms of carbon taxes and subsidies. Investors are always free to compete, provided they do not lean on government support to gain competitive edge. “Cheaper” solar cannot claim costs advantage while continuing to receive P8.50/kWh in FiT in a P2.50/kWh power market.

Fixing poor energy logistics is the path to cheaper power supplies. Access to market is a function of price, and available infrastructure and logistics, to deliver power from source to demand. Paradoxically, “cheap” solar power becomes expensive when congested grid prevents its use.

By singularly taxing coal, without resolving the infrastructure bottlenecks, consumers are hit twice. They subsidize solar power without coming close to securing power supplies, while paying more for their electricity generated from coal.

Inadvertently, could the coal tax transform candle making into the next boom industry, when severe blackouts finally hit us again, and again?

Ricardo G. Barcelona is Professorial Lecturer at School of Economics, University of the Philippines. He is author, Energy Investments: An adaptive approach to profiting from uncertainties to be published by Palgrave Macmillan, in 2018. He has PhD in Management, King’s College London, and a managing director of Barcino Advisers, Hong Kong.