Saturday, May 19, 2012

Why Solar Electricity Doesn't Fly in Palestine -- and How to Make it Fly

This post calculates a photovoltaic (PV) investment for a home owner or for a small/medium enterprise. It leads to the conclusion that -- regardless of existing grid parity in Palestine -- the envisioned regulation for electricity feed-in in Palestine is likely to discourage private investment.

This post should serve Palestinian private property owners or small- and medium enterprises to calculate whether investment in solar electricity will be profitable for them -- and under which circumstances it may become profitable.

There are other calculators available online, but this post will focus on the special case of Palestine.

Risk of Israeli Bulldozers

There has been a lot of media coverage on the Israeli military administration of the West Bank threatening to destroy Palestinian solar installations -- while donors are still continuing such risky investments, private investors will be hesitant to spend money on anything likely to confront Israeli bulldozers (besides, private investors are hesitant to spend their own money because they might miss a bargain of international donors carrying the investment cost in part or whole with yet another solar pilot project).

What media doesn't mention though, is that these bulldoze-threats exist in C-Areas only (background: what is C-Area?), while investment in solar electricity in B-Areas and A-Areas are safer. Also Gaza, regardless of the threat of air raids, seems to be much safer for such investment than C-Areas. So in this financial analysis, I will be considering a low-risk environment of either an A-Area, B-Area, Gaza, or a rooftop installation of a legal building in C-Area (legal by standards of Israeli military administration). So those are environments without bulldozer-threats.

Note that this applies for PV only -- wind turbines have different issues, because they may reduce the radar range of Israeli military, and therefore are subject to demolition anywhere in Palestine.

Investment Cost

Solar electricity is a capital-intensive investment. Almost the entire total cost of ownership (TOC) is paid upfront, with a very low fraction of maintenance cost during its lifetime. The lifetime of photovoltaic (PV)-cells is assumed to be around 40 years, but we will calculate the investment for 20 years only, because most people's investment horizon doesn't go further than that, and we still can inherit some free electricity for the next generation to live on.
Normally, you calculate the price per KWp (Kilowatt peak production), which fell dramatically in the recent years, mostly thanks to Chinas heavily subsidized huge investments in photovoltaic (PV) module factories. In Europe, price per KWp of turn-key rooftop installation is available at around 1700 EUR (as of March 2012). Palestine has tax-exemption for PV modules, and the rooftop-mounting cost can be considered significantly lower than in Europe thanks to cheaper labour. So let's assume conservatively a price of 1500EUR per KWp.

So in our example, we will take a 5KWp installation, which would cost 7500 Eur or around 10,000 US$ upfront investment. I talked to some Palestinian entrepreneurs in that field and they confirmed this cost estimate to be realistic.

Interest Rate or Opportunity Cost

Some may need a bank loan for their investment, so they might have to pay an annual 10% interest for their investment. Under market conditions, the actual interest rate depends on the prime rate (which is currently close to 0.5%), and on the risk of the investment (see above, relatively low), and the creditworthiness of the client. In addition, the interest rate can be lowered by credit guarantees (several international donors are giving up to 70% credit guarantee to Palestinian banks), through soft loans earmarked for renewable energy or through Islamic banking principles which package the interest rate into a deal of Mudharabah, Musharakah, Murabahah, or Ijar often at very attractive de-facto interest rates, thanks to generous subsidies to Islamic banking from Gulf countries.

Also, many Palestinian property owners who consider solar investments have their own savings, so for those, instead of an interest rate, you calculate the opportunity cost (assuming that their money, if it wasn't invested in solar panels, would be creating an annual interest of 2.5% as a bank deposit).

In our example, I will assume an average annual 5% interest rate, which reflects a mixture of some savings and some loan with reasonable interest rates -- the actual rate may vary according your particular case.

Use any loan calculator like for example this one, and you will get a monthly payment of 66$ or annual payment of 792$ that you need to recover from the electricity produced by your solar panels. (the accumulated interest over 20 years amounts to 5,840$ in this example -- so you can save a lot if you use your own money instead of borrowing)

Sun Radiation in Palestine

Depending on the sun radiation, you get different annual yields per KWp of solar cells on your roof. This site calculates the yield depending on your location, being approximately 1500 KWh per year for each KWp in Palestine. So in our example of 5 KWp on your roof, you will have an annual 7500KWh of solar electricity production (taking into account 14% system losses from the wiring and inverter).

Production Patterns and Consumption Patterns

The sun shines in the daytime, while most household electricity is consumed in morning and evening hours. Because storage in batteries is very expensive and has high maintenance cost, we are looking into feeding the excess electricity back into the network.

The chart above is a scenario of how solar electricity production pattern is matching with your household consumption pattern during a typical day. The red color shows the electricity that you buy from the network. The yellow color shows the electricity that you produce yourself, and the green color shows the excess electricity that you want to sell to the network.

The bigger your installation is, the larger the yellow and green portion will appear in the graph. In our example with an annual production of 7500KWh, the daily production is about 20KWh, so in fact you will have much more green than in the chart above.
For a realistic figure for private households with 5KWp of solar panels is that they can use maybe 30% themselves (yellow), and have to feed in 70% of their production into the grid (green).

For industry or commercial buildings, it is the other way round, they consume most during daytime, and don't consume at night, and on weekends. So they will be able to use about 80% of their production themselves, and feed in the remaining 20%.

While the red electricity costs you 0.53 Shekel per KWh, it depends on the regulator Palestinian Energy Authority (PEA) on how much you can profit from the yellow and green portion of electricity per KWh.

Feed-In Regulation -- how much you get for the yellow and green portion

Many countries in the world subsidize renewable electricity through feed-in tariffs, that means that solar investors can sell their yellow and green portions at prices which are higher than the retail tariffs. This subsidy is paid either directly by the government or by electricity consumers. Given the tough situation of Palestinian Authority's budget, and the already high price burden on Palestinian electricity consumers, it will be hard to find consensus on subsidized feed in tariffs -- but here comes the good news: There is actually no need for subsidies to make solar investments profitable in Palestine -- thanks to lots of sun, thanks to cheap modules from China, thanks to cheap labour, and last but not least thanks to the high retail prices for electricity in Palestine. Neighbouring countries like Egypt that heavily subsidize conventional fuels would likewise need heavy subsidies on renewable energy to make it profitable. Palestine is unique in the Arab region in reaching grid parity.

The alternative to subsidized feed-in tariffs is net-metering -- meaning that on your monthly electricity bill, you will pay only for the difference between the Kilowatt-hours you buy from the grid (red) and the Kilowatt-hours fed-in to the grid (green). In other words, your entire solar production would be worth 0.53 Shekel per KWh. Net metering does not need any subsidies, and as the following calculation shows, it offers a profitable business model for property owners or small and medium enterprises:

So, with net metering, your annual production of 7500KWh is worth 0.53 Shekel per KWh, that means 3,975 Shekel per year, or 1,038 US$ per year. So you can pay back your loan at 792$ annually, and have an extra 246$ each year of profits at your disposal.

After 20 years, the total profit is almost 5000$ plus interest, and if your PV cells survive for 40 years, you will have over 25,000$ profit, plus interest.

The Palestinian Energy Authority (PEA) -- A Show Stopper?

The PEA has plans to introduce a country wide net-metering regulation -- so are we about to witness a boom of solar installations that will make Palestine energy independent, create a lot of jobs for electricians, carpenters, metal construction, financial industry, and cleaning & maintenance companies, and leave a decent profit for investors? Hardly. The devil is in the detail.

If you look into the plans of the PEA, you will notice that what it calls "net metering" is actually not the same as commonly understood as net metering. Instead of feeding electricity into the network (the green portion) at retail prices of 0.53 Shekel per KWh, the PEA wants electricity companies to compensate that portion with only 0.38 Shekel per KWh -- leaving a decent profit margin for distribution companies, at no additional infrastructure cost. (infrastructure needs some upgrades only once solar production reaches about 30%-40% of total consumption). This dramatically changes our example calculation:

So, the self-produced and self-consumed portion, that is 30% of 7500KWh, that is 2250KWh is worth 0.53 Shekel each, i.e. total 1,192 Shekel.
The feed-in (green) portion, 70% of 7500KWh, that is 5250KWh is worth only 0.38 Shekel each, i.e. total 1,995 Shekel
The total annual production is worth 3,187 Shekel, or 830 US$... this is merely enough to pay back the loan, and maybe pay someone to wash the modules every now and then, but it will not leave any significant profit for the investor.

Even worse, the PEA intends to have two separate electricity meters installed, one for production, one for consumption. This way, people will not even be able to directly make use of their own production, but instead they have to sell their entire production (yellow) at the low price of 0.38 shekel to the electricity company.

In this model, the entire 7500 KWh is worth only 0.38 Shekel each, resulting in annual revenues of 2850 Shekel, or 745 US $ -- that's not even enough to pay back the loan.

Now the difference of 1,038 $ annual revenues through proper net metering or 745 $ annual revenues through "PEA net metering" reflects an implicit taxation of renewable energy amounting to 293$ per year in our example. That's for sure a way to keep municipalities' and electricity companies' coffers filled, but hardly a way to lead Palestine out of energy dependency.

So What About the Palestinian Solar Initiative (PSI)?

PSI of PEA comprises a 1000-roofs program of up to 5KWp each. Its implementation is pending a large donor contribution to cover expenses of the Energy Authority itself, to subsidize PV modules investments, and to subsidize the net metering tariff (bridging the gap between the above mentioned 0.38 Shekel and 0.53 Shekel), as well as some training, capacity building and certification mechanism.

A 1000 roofs initiative sounds good in principle -- better slow than never. So what are the pros and cons about that initiative?

  • The tight governmental regulation, the technical training and certification will set some quality standards and build capacities in solar firms.
  • All participants will have time to get used to the new technology and cooperation.

  • A 1,000 roofs initiative with net-metering (feed-in at 0.53NIS) distracts from the need for country wide net-metering at retail price, which has potential coverage in the range of 100,000 roofs rather than just 1,000 -- eventually making Palestine an electricity exporter rather than importer.
  • The fact that subsidized investment is available will make private investors hesitant to invest their own money, because they may be hoping to strike a better deal through any next potential upcoming 1,000 roofs initiative.
  • Donor money earmarked for renewable energy goes into the coffers of municipalities and electricity companies (donors pay the difference between 0.38 Shekel and 0.53 Shekel -- this margin is the profit of municipalities and electricity companies)
  • With a heavy subsidy on the capital cost, and a meager compensation for feed-in, people might be tempted to buy the PV modules, keep the subsidy in cash, and sell the modules again -- either to Israel or to another Palestinian household who does the same trick.

The Steps Towards Country-Wide Net-Metering

The regulatory solution, to enact proper net metering will need a political consensus to be found with municipalities and electricity distributors. Currently, those two stakeholders are profiting from the margin between the Israeli wholesale price of 0.38 Shekel and the retail price of 0.53 Shekel to finance their operations.

Municipalities are having plenty of unaccounted electricity for which the central PA government pays the bills to Israel. This indirect and in-transparent money transfer from central government to municipal level should be revisited. Separating the municipal coffers from electricity revenues is best achieved through some degree of privatization that would create an incentive for efficient management and reduction of non-technical losses (electricity theft). A good model is a privatized management that is remunerated based on key performance indicators (KPIs like reduction of technical and non-technical losses, availability, customer service quality). That could be an efficient model to decrease operation cost, and taking the burden of PA paying for unaccounted (stolen) electricity. Municipalities that used to profit from PA government paying their electricity bills, could in the future receive that money in a more transparent way directly from PA.
It is a politically complex transition, where influential people would loose some stakes, but once that is achieved, municipalities and electricity distributors will no longer stand in the way against net metering at retail price (of currently 0.53 Shekel).

That was the political level. The technical level seems to be easier to handle, and deals mainly with three challenges:
  • Grid code -- this is determined essentially by Israeli power plants, which still constitute the main supplier. All it needs is a translation from Hebrew to Arab language and possibly some minor adoptions and enforcement mechanism.
  • Safety -- The process of connecting an inverter to the grid and installing the bidirectional meter should be carried out by some trained and authorized person to avoid electric shock risks. The low voltage system of the cells has less risks-- you can leave that to the forces of the market.
  • Upgrading the grid -- once the solar production reaches about 40% of total electricity consumption, the grid needs some upgrades to make energy flow of upper grid levels possible in both directions. This type of investment could possibly be carried by the international donor community once the need arises, and under the condition that net metering is offered at retail prices.

In case the regulatory process doesn't advance quickly enough towards real net metering, creative entrepreneurs need to think of alternatives on how to make PV-investment profitable. These are a few approaches...

  • Focusing on commercial buildings, industrial sites/zones or larger development projects which can absorb close to 100% of the electricity production themselves without the need of interacting with the electricity company in this regard (maximize and use the yellow portion, and throw away the green portion). Some industrial sites have already adopted this approach.
  • For households: Avoiding the need of interacting with the electricity company by minimizing the green portion in the daily consumption graph, and buying a battery buffer for this portion, which would carry the daytime production into the evening. Battery buffer is interesting in particular for Gaza which is plagued by frequent black-outs. Used car-batteries can provide cost-efficient means of storage.
  • For those households that have an old-fashioned electricity meter installed, they may have net metering up and running already -- many old electricity meters can run backwards by default. Those households need to be careful not to surprise the distribution company with a negative power bill, and on the other side they should take measures to protect workers (in case the grid is shut down for maintenance, feed in needs to stop -- otherwise you could endanger electricity company's maintenance workers).

A Political Compromise

As Bruce Bueno De Mesquita teaches, the primary goal of any political leader is to stay in power, and any leader who dares to take money out of the pockets of his essential supporters, takes a risk of being removed from his position. A ground-breaking reform of the electricity market as proposed in the previous chapter might be one of those cases.. depending on how powerful the stakeholders in municipalities and electricity companies are -- it might be the end of your political career if you take money from their coffers by reforming the system.

So even a politician with best intentions to make Palestine energy-independent has to be careful in his steps.
The proposed feed-in at 0.38 Shekel is likely to be the result of such careful steps -- this rate doesn't interfere with the profit margins of electricity distributors.

One approach is to raise the decision to a higher level. The prime minister may be less threatened by the lobby of electricity distributors than the head of the energy authority is. This however requires this relatively complicated subject matter to be broadly understood. My blog tries to contribute to this to certain extent.

Another approach is to reach a compromise. For instance, it is understandable that electricity distributors would charge their profit margin of 0.15 Shekel per KWh for storage of electricity in the grid (the green portion), while it is hard to understand why consumers are not allowed to use their own electricity as they produce it. Instead they have to sell it to the distributor at the low price, and in the same second buy it back at a higher price.

I believe there could be a broad consensus among the population, especially those seeking energy independence from Israel, that people can use their self-produced electricity immediately without giving a 0.15 Shekel per KWh premium to the distribution company.

Would this political consensus still be profitable enough?

The electicity produced and consumed immediately being worth 0.53 Shekel per KWh, and the green portion stored in the grid being worth 0.38 Shekel per KWh, the example above was calculated to generate 830 US$ per year. With annual loan payments of 792$, that is just enough to pay back the loan and pay for maintenance, but not really profitable.

So how can, under conditions of this political compromise, how can we tweak the calculation to make the investment profitable?
The smaller the installation is, the higher the percentage of self-consumption, and the lower the percentage of feed-in, so for instance, we take a 2KWp installation instead of 5KWp. For that installation we assume a 50% self-consumption, 50% feed-in ratio. In Jericho climate, the figure might look even better thanks to air conditioning in daytime.

The lower the interest, the better the profitability, so we take an example of a soft loan at 2.5% interest. Now the calculation looks like this:

Investment: 2 * 1500 Eur = 3000 Eur or 3834 US$.
Annual loan pay back at 2.5% interest: 244 $
Annual yield: 2 * 1500KWh = 3000KWh
Own consumption portion of 50%: 1500KWh * 0.53 ILS = 795 ILS = 208$
Feed-in portion of 50%: 1500KWh * 0.38 ILS = 570 ILS = 149$
Total annual revenue: 208$ + 149$ = 357$
Annual profit: 357$ - 244$ = 113$
Total profit over 20 years: 2260$ plus interest
Total profit over 40 years, provided the PV cells survive: 9400$ plus interest

This sounds reasonably profitable, so my proposal to move forward towards is
1. Convincing the local authorities about the need for this political compromise, and
2. Ask donors (including islamic banking donors from the Gulf) to facilitate soft loans at very low rates.

For the first one, I would rely on the lobby of renewable energy entrepreneurs like the renewables council inside chambers of commerce, property owners, NGOs like PSSES, academia like Najah University or Polytechnic in Khalil. Besides those special interest groups, a broader concerned audience may include lobbyists for Palestinian economic independence from Israel, Islamic groups (green is the colour of Mohamed's tribe; A good Muslim should not pollute his environment; there are some verses in Quran that can be interpreted as reference to solar energy).

The second one -- soft loans -- may be triggered by the new regulation and debate among donors, which can be sparked through debate of above lobbyists.


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