Chapter

Chapter 13. Energy Diversification: Macro-Related Challenges

Author(s):
Krishna Srinivasan, Inci Otker, Uma Ramakrishnan, and Trevor Alleyne
Published Date:
November 2017
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Author(s)
Meredith A. Mcintyre and Ahmed El Ashram 

Introduction

The cost of electricity in the Caribbean has been persistently high over the past two decades, and has eroded competitiveness. This situation is largely due to serious inefficiencies in the power sector and dependence on expensive imported petroleum products, reflecting limited energy diversification. In turn, these problems have contributed to the region’s high cost of doing business and increased external sector vulnerabilities, and have undercut growth in many Caribbean economies.

The substantial decline in oil prices since mid-2014 does not obviate the need for energy sector reform. The impact of the oil price decline is global, so it has not improved relative prices for the Caribbean compared with its trading partners. Moreover, competitiveness challenges are escalating, particularly with the appreciation of the U.S. dollar, to which many Caribbean countries are pegged. Hence, any gains from oil price declines only provide a temporary respite; solutions for sustained cost reductions are still needed for the region to be competitive.

The chapter focuses on answering some fundamental macro-level questions related to moving energy reform forward in the region. First, how important is energy sector reform to boosting growth and competitiveness? Second, are existing energy sector strategies adequate for addressing current challenges? Third, what gains could be expected from the implementation of these energy strategies? Fourth, what investment costs would be associated with achieving the announced energy targets? And fifth, could countries afford it—in other words, would the envisaged energy reform be consistent with preserving fiscal space and debt sustainability?

State of the Caribbean Energy Sector

Caribbean countries (other than Haiti) have very high access to electricity,1 but use expensive off-grid supply to compensate for deficiencies in the utilities generation and transmission of power. Although each country has unique energy sector conditions, most face the same supply constraints, including limited generation capacity, outdated power systems, isolated grids, and lack of technical expertise, which, combined with episodes of high and volatile oil prices, have resulted in high average electricity costs. Electricity tariffs increased by almost 80 percent from 2002 to 2012 (Figure 13.1), exceeding US$0.30 per kilowatt-hour for most of the region in 2012 (Figure 13.2).

Figure 13.1.Caribbean Residential Electricity Tariffs 2002–12)

(US ¢/kWh)

Sources: CARILEC Tariff Survey 2012; and U.S. Energy Information Administration database.

Note: Includes data for The Bahamas, Barbados, Belize, Dominica, Grenada, Jamaica, St. Lucia, and St. Vincent and the Grenadines; limited data available for Antigua and Barbuda and Nevis; excludes Trinidad and Tobago and Suriname.

Figure 13.2.Domestic Electricity Tariffs, 2012

(U.S. ¢/kWh)

Sources: CARILEC 2012; and World Bank staff estimates.

Note: LAC = Latin America and the Caribbean.

The single most important cost problem is the region’s heavy dependence on expensive imported fossil fuels. As in the United States, the cost of using petroleum to produce electricity is several times higher than the cost of alternative fuels. Except for Trinidad and Tobago—the only net exporter of oil and natural gas—all Caribbean countries are net oil importers.

For importers, other than Suriname,2 about 87 percent of primary energy consumed is in the form of imported petroleum products (Figures 13.3 and 13.4).3 Imports are mostly diesel fuel for electricity generation, gasoline for transportation, and liquefied petroleum gas for cooking use in households. Of the net oil importers, only Barbados and, more recently, Jamaica have installed capacity that uses natural gas4 for electricity generation (Figure 13.3.), which has partly contributed to its higher efficiency rates.5 Hydroelectric power, harnessed through facilities in Belize, Dominica, St. Vincent and the Grenadines, and Suriname, supplies about 6 percent of regional electric energy consumption. Excluding Haiti, biomass accounts for about 11 percent of Caribbean energy supply, mostly concentrated in Jamaica.

Figure 13.3.Installed Generation Capacity in Caribbean Countries

(Percent of total capacity)

Sources: Inter-American Development Bank; World Bank; and IMF staff calculations.

Note: LAC = Latin America and the Caribbean.

An important characteristic of the power sector in the Caribbean is that the market structure is not diversified and is underregulated, resulting in inefficient, high-cost supply. Regulatory deficiencies impede greater involvement of the private sector in the industry. The Caribbean electricity market is served by a mix of state-owned and private utility companies (Table 13.1). For the most part, electric utilities are vertically integrated monopolies that hold exclusive licenses for generation, transmission, distribution, and sale of electricity. Some of these monopolies are unable to finance necessary investments in generation capacity and the national grid, leaving consumers with unreliable and unaffordable energy access. As discussed later in the chapter, if weaknesses in regulation related to independent power producers (IPPs)6 were to be addressed, private sector participation in the electricity sector could be enhanced.

Table 13.1.Electric Utility Companies in the Caribbean
CountryMain UtilitiesOwnership
Antigua and BarbudaAntigua Public Utilities Authority (APUA)State owned
The BahamasBahamas Electricity Corporation (BEC)State owned
Grand Bahama Power Company (GBPC)Privately owned
BarbadosBarbados Light and Power Ltd.Privately owned
BelizeBelize Electricity LimitedState owned
DominicaDominica Electricity Services Ltd. (DOMLEC)Privately owned
GrenadaGrenada Electricity Services Ltd. (GRENLEC)Privately owned
GuyanaGuyana Power and Light Inc. (GPL)State owned
JamaicaJamaica Public Service Company (JPSCo)Privately owned
St. Kitts and NevisSt. Kitts Electricity Co. Ltd. (SKELEC)State owned
Nevis Electricity Company Ltd. (NEVLEC)State owned
St. LuciaSt. Lucia Electricity Services Ltd. (LUCELEC)Private-public entity
St. Vincent and the GrenadinesSt. Vincent Electricity Services Ltd. (VINLEC)State owned
SurinameEnergy Companies of Suriname (EBS)State owned
Trinidad and TobagoTrinidad and Tobago Electricity CommissionState owned
Power Generation Company of Trinidad and Tobago Ltd. (PowerGen)Private-public enterprise
Sources: National Renewable Energy Laboratory; and Organization of American States.
Sources: National Renewable Energy Laboratory; and Organization of American States.

Despite high prices, Caribbean energy consumption has been growing, put-ting further pressure on total energy bills. Consumption has grown fastest in energy-rich Trinidad and Tobago because of the abundance of natural gas, cheap electricity, and significant expansion of its hydrocarbon industries. Consumption in the smaller Eastern Caribbean countries that import oil also grew—almost tripling to 28.7 trillion British thermal units in 2012. The transformation of many Caribbean economies from reliance on agriculture to reliance on tourism has been accompanied by significant capital accumulation and expansion of energy consumption as energy needs of the tourism industry have increased. On a per capita basis, tourism-dependent Caribbean economies appear to be more energy intensive than commodity-exporting countries like Belize, Guyana, and Suriname (Figure 13.5).

Figure 13.4.Primary Energy Consumption by Source and Use

(Percent of total)

Sources: Inter-American Development Bank; U.S. Energy Information Administration database; and IMF staff calculations.

1 Excludes Haiti and Trinidad and Tobago.

2 Includes hydroelectric power, geothermal, solar/photovoltaic, wind, and biomass.

3 For the Caribbean, renewables include hydropower and biomass.

Figure 13.5.Energy Consumption per Capita, 2012

(Million BTU per capita)

Sources: U.S. Energy Information Administration database; and IMF staff calculations.

Note: BTU = British thermal unit.

1 Includes Eastern Caribbean Currency Union countries, Barbados, and The Bahamas.

2 Includes Jamaica, Belize, Guyana, and Suriname; excludes Trinidad and Tobago.

The Macroeconomic Impact of Energy Costs

The region’s dependence on imported fossil fuels exposes the countries to adverse oil market developments, terms-of-trade shocks, fiscal costs, and resulting macro-economic imbalances (Figure 13.7). In the net oil-importing countries, the average value of net oil imports doubled between 2005 and 2014. This increase widened the trade deficit by an average of 3.7 percent of GDP annually compared with the previous decade, and put pressure on foreign exchange reserves. The domestic economy has also suffered from high oil prices.

  • About 40 percent of Caribbean firms identify electricity costs as a major constraint to doing business, compared with the average of about 30 percent in the LA6 group and other developing countries (Figure 13.6).7 This creates increased uncertainty for domestic and foreign investment, with unfavorable repercussions for capital formation, the inflow of foreign direct investment, and long-term growth.
  • The high pass-through of oil price shocks has also contributed significantly to inflation dynamics through the higher cost of electricity (a fuel surcharge) and higher transportation costs. Some of the energy price movement filters into core inflation and further affects competitiveness (Figures 13.8 and 13.9).8

Figure 13.6.Average Current Account Deficit in the Caribbean

(Percent of GDP)

Sources: Country authorities; and IMF staff calculations.

Note: Excludes Haiti and Trinidad and Tobago.

Figure 13.7.Electricity as a Major Constraint to Firms

Sources: World Bank Enterprise Survey 2015; and IMF staff calculations.

Note: LA6 = Latin American 6 (Brazil, Chile, Colombia, Mexico, Peru, Uruguay).

Figure 13.8.ECCU: Energy Price Volatility vs. Core Inflation

(Year-over-year percent change)

Sources: Eastern Caribbean Central Bank; and IMF staff calculations.

Note: Core inflation excludes food and fuel; weights are based on St. Lucia consumption basket. ECCU = Eastern Caribbean Currency Union.

Figure 13.9.Core Inflation Indices and Oil Price Volatility

(Year-over-year percent change)

Sources: Country authorities; and IMF staff calculations.

Note: Core inflation excludes food and fuel. In Suriname, fuel tax increased by 70 percent in January 2011.

Impact of Energy Costs on Growth: How Important?

To analyze the macroeconomic effects of energy costs in the Caribbean, the impact of oil price shocks on near-term growth and the real exchange rate was modeled.9McIntyre and others (2016) also examined the potential for improvements in the power sector’s efficiency to deliver higher long-term sustainable growth. Overall, the investigation found that changes in real oil prices have an important short-term impact on growth, although other factors dominate. Estimates suggest that movements in real oil prices explain, on average, 7 percent of real GDP growth variation in the Caribbean (Figure 13.10)—with variability across countries ranging from 15 percent in Dominica to less than 1 percent in Guyana.10 These results suggest that a reduction in countries’ dependence on oil would materially alleviate the cost of adverse oil price movements. However, the exercise also showed that a greater share of real growth variation (30 percent) is explained by external demand shocks—meaning that energy sector reform alone is not a panacea for solving Caribbean growth problems.11 Estimates also suggest that a 10 percent increase in oil prices could lead to an appreciation of the real effective exchange rate (that is, reduce competitiveness) by 2.8 percentage points over five years in tourism-intensive economies and by 3.8 percentage points for commodity producers.12

Figure 13.10.Impact of External Factors on Real GDP Movements

(Percent, average over three years)

Source: McIntyre and others (2016).

Note: AEs = advanced economies. Data labels in figure use International Organization for Standardization (ISO) country codes.

The negative impact of oil prices on growth and external competitiveness can be mitigated through efforts to reduce oil dependency and lower the energy bill. Although countries have no control over oil price movements, they can save over the longer term by diversifying their energy mix and improving the efficiency of energy consumption to reduce fuel imports and thereby limit the impact of price shocks. To assess the potential effectiveness of such savings, McIntyre and others (2016) estimate the impact of energy consumption and efficiency on long-term output.13 Their analysis indicates that an improvement of 1 percent in energy efficiency14 would be accompanied by a 0.2 percent increase in GDP per capita in the long term. An increase of 1 percent of gross capital formation per capita is associated with a 0.15 percent increase in long-term GDP per capita.15 In sum, the analysis indicates that improving energy efficiency, including through diversification of the generation mix by incorporating cheaper and more efficient alternative energy sources and by adopting energy efficient technologies, will have a significant impact on GDP in the long term.

Caribbean Energy Sector Strategies

Caribbean authorities have recognized energy sector challenges and the negative implications for their economies since the mid-2000s. Most countries have formulated draft energy policies that spell out key objectives and a general framework that focuses on shifting to cheaper energy sources and improving energy efficiency. In some countries, action plans have been developed with specific targets, although progress on implementation remains slow. In 2013, a Caribbean-wide initiative16 was undertaken to harmonize these policies, and an overall regional strategy was developed. Figure 13.11 summarizes existing and proposed reforms in Caribbean Community (CARICOM) states.

Figure 13.11.Summary of Existing and Proposed Energy Policies in CARICOM States

X denotes implemented.

Source: Mclntyre and others 2016.

Note: IPP = independent power producer.

McIntyre and others (2016) survey countries’ existing energy strategies and find that most of them reflect international best practices advice on policies to achieve energy sector transformation—regulatory reform, energy efficiency improvements, and diversification of the generation mix. Regional targets17 for energy efficiency, renewable power generation, and carbon dioxide emissions are well aligned with national targets for energy efficiency and renewable energy. Hence, the Caribbean already has in place most of the key building blocks needed to achieve substantial energy reform, albeit with some important exceptions on the regulatory side.

Regulatory Reforms

Reform of the legal and regulatory framework for the Caribbean power sector is the first important prerequisite for sustainable and affordable energy solutions. Reforms that address regulatory deficiencies relating to IPPs are key. Although independent generation is permitted in many Caribbean economies, no clear framework governs the licensing of utility-scale IPPs and their ability to sell to the grid. Facilitating licensing procedures and introducing feed-in tariffs and net billing schemes are likely to be critical to the development of private sector–led projects that supply electricity to the grid at competitive cost. IPPs are particularly instrumental for exploiting the renewable energy potential in the region, and because these projects involve large upfront capital costs and no fuel cost, feed-in tariffs and net-billing schemes should aim to establish adequate cost recovery mechanisms to ensure viability while reducing the overall cost of energy. So far, net metering18 has been introduced in Barbados, Grenada, Jamaica, and St. Lucia. Creation of independent national and regional regulators would help promote a predictable and transparent regulatory environment for energy investors. The lack of an independent regulator in many Caribbean countries is an impediment to new market entrants, given the need to assure them of a level playing field. Establishing an independent power sector regulator requires building sufficient institutional capacity to competently perform the key functions of tariff setting, license issuance, and effective market oversight. The office of the pilot launch of the Eastern Caribbean Energy Regulatory Authority project in Grenada and St. Lucia supports these objectives in the Eastern Caribbean Currency Union (ECCU), as does the Office of Utility Regulation in Jamaica.

Energy Efficiency

Energy efficiency measures—for both generation and consumption—are a focus in most country strategies, and are likely to be the most feasible short- and medium-term way to reduce energy costs.

  • On the generation side, gains could be achieved by replacing old and inefficient power plants and transmission and distribution lines, which cause major technical losses for the grid.
  • On the consumption side, improving the energy consumption patterns of heavy energy users is key. For example, in small tourism-dependent countries, improving the energy efficiency of hotels through the adoption of energy-efficient technologies could significantly reduce the national energy bill and improve tourism competitiveness.19
  • Despite potential gains from energy efficiency, the region has not taken decisive action to implement rules-based policies. Generally, policies to promote efficiency improvements should focus on (1) encouraging households and businesses to buy energy-efficient appliances; (2) promulgating energy-efficient building codes, particularly for hotels; and (3) requiring energy labeling for consumer goods and appliance efficiency standards to encourage the use of energy-efficient items. However, such policies have not been adopted in the region because of constraints on financing, weaknesses in institutional capacity, and insufficient expertise regarding labels and standards.
  • Some CARICOM states have set energy efficiency targets that, if achieved, would have a positive macroeconomic impact. For instance, if Antigua and Barbuda meets its target of improving overall energy efficiency in the economy (including the transport sector) by 20 percent, estimated impacts include an equivalent 20 percent drop in oil imports, a 13 percent decline in the national energy bill, and a long-term cumulative increase of 4 percent in the level of GDP.20

Energy Diversification

The other focus of most reform strategies is diversification of energy sources, especially toward cost-effective renewables. Some Caribbean countries already have existing renewable energy capacity in their generation mix. Although Belize and Suriname have considerable renewable power capacity, more than half of the countries in the region still have a very low share of renewables in their energy mix.

The region possesses significant potential for the use of renewable energy. Some CARICOM states have conducted assessments that provide an overview of available renewable energy resources (Table 13.2). Except for Antigua and Barbuda, ECCU countries have significant geothermal potential that could cover their likely base load, potentially allowing for self-sufficiency in electric power generation. Geothermal development is advanced in Dominica, Nevis, and Montserrat, with progress in St. Vincent and the Grenadines. St. Kitts and Nevis has launched several solar power initiatives, including two solar farms, while in Jamaica, three renewable energy projects have recently been developed—two wind plants and a solar farm.

Table 13.2.Summary of Viable Renewable Energy Sources by Country
CountrySolarWindGeothermalHydroBiomass
Antigua and Barbuda
Dominica
Grenada
St. Kitts and Nevis
St. Lucia
St. Vincent and the Grenadines
The Bahamas
Barbados
Guyana
Haiti
Jamaica
Suriname

Quantitative estimates indicate significant positive macroeconomic impacts from meeting the renewable energy targets in the CARICOM roadmap.21

Potential Gains from Reform

Taken together, the quantitative estimates indicate that substantial potential gains could be obtained from pursuing already-specified energy strategies. Tables 13.3 and 13.4 present summary estimates of what could be achieved by meeting country targets for efficiency improvements and renewables. Although some national targets are quite ambitious (such as 100 percent renewables in Dominica and Grenada), and the estimates of gains from meeting the targets are necessarily broad-brush, they illustrate the scope for eventual savings with energy transformation.

Table 13.3.Implied Effects of Energy Efficiency Targets
Implied Effects
CountryEffective Efficiency Target1 (%)Implied reduction in oil imports (%)Implied reduction in national electricity bill2 (%)Implied impact on long-term GDP level (%)
Dominica1110
St. Lucia1110
Barbados121192
St. Kitts and Nevis121182
St. Vincent and the Grenadines121052
Antigua and Barbuda2020134
Belize3302016
Jamaica71693114
Sources: McIntyre and others 2016; Castalia Strategic Advisors 2010, 2013; Inter-American Development Bank; IMF, World Economic Outlook; and IMF staff estimates.

Announced efficiency targets presented in the Caribbean Sustainable Energy Roadmap are normalized to the same base to reflect targeted improvement in energy consumption in the entire economy, including the transport sector.

Reflects savings in the energy bill of end users from introducing energy-efficient technologies at an average cost of US$0.13/kWh.

The impact on the national electricity bill from achieving the target reflects the smaller savings from energy efficiency technologies in Belize, where the electricity tariff rate is relatively low.

Sources: McIntyre and others 2016; Castalia Strategic Advisors 2010, 2013; Inter-American Development Bank; IMF, World Economic Outlook; and IMF staff estimates.

Announced efficiency targets presented in the Caribbean Sustainable Energy Roadmap are normalized to the same base to reflect targeted improvement in energy consumption in the entire economy, including the transport sector.

Reflects savings in the energy bill of end users from introducing energy-efficient technologies at an average cost of US$0.13/kWh.

The impact on the national electricity bill from achieving the target reflects the smaller savings from energy efficiency technologies in Belize, where the electricity tariff rate is relatively low.

Table 13.4.Implied Effects of Renewable Energy Targets
Implied Effects1
CountryRenewable Energy Target for Electricity (%)Implied reduction in oil imports (%)Implied reduction in the national electricity bill2 (%)Implied impact on long-term GDP level (%)
Antigua and Barbuda201061
Jamaica20540
Barbados291361
The Bahamas3017111
St. Lucia3522111
St. Kitts and Nevis3402491
Belize8925101
Guyana9028212
Dominica10045162
Grenada10049313
Sources: McIntyre and others 2016; Castalia Strategic Advisors 2010, 2013; Inter-American Development Bank; and IMF staff estimates.

Reflects the impact of achieving the target using viable renewable power technologies, up from the existing renewable penetration rate in each country.

Assumes a 100 percent pass-through of cost savings from renewable energy technologies to end users.

Target is the average of a 20 percent renewable target for St. Kitts and 100 percent target for Nevis, weighted by size of electricity generation on each island.

Sources: McIntyre and others 2016; Castalia Strategic Advisors 2010, 2013; Inter-American Development Bank; and IMF staff estimates.

Reflects the impact of achieving the target using viable renewable power technologies, up from the existing renewable penetration rate in each country.

Assumes a 100 percent pass-through of cost savings from renewable energy technologies to end users.

Target is the average of a 20 percent renewable target for St. Kitts and 100 percent target for Nevis, weighted by size of electricity generation on each island.

Energy Sector Transformation: Costs and Feasibility

Implementation of the national and regional energy strategies requires substantial upfront investments to achieve the targets, but these costs are not quantified nor is the financing sourced. Significant investment is also needed to upgrade existing power infrastructure, reduce technical losses, and ensure system integrity as electricity demand grows. With the support of the Inter-American Development Bank (IDB), McIntyre and others (2016) estimate the investment envelope needed to implement the energy strategies already specified by Caribbean countries.

Energy Investment Needs

Based on the IDB’s estimates, total energy sector investment requirements are about 7 percent of regional GDP (Table 13.5). These include investments to (1) expand and upgrade existing power plants to meet growing electricity demand, improve generation efficiency, and reduce system losses; (2) introduce renewable energy sources (geothermal, solar, wind, and hydro) where the associated technologies are viable; and (3) implement energy efficiency initiatives (for example, solar water heating systems and smart street lighting).22 In addition, the IDB also estimated the size of the investment envelope for introducing natural gas in Western Caribbean countries.

Table 13.5:Energy Sector Investment Needs in the Caribbean (2018–23)(Millions of US. dollars)
Building or Upgrading Power Plants1Introducing Natural Gas Facilities2Renewable Energy Investments3,4Energy Efficiency and Conservation Initiatives5Total InvestmentTotal Investment (% of GDP)6Average GDP Growth (2006–15)Gross Public Debt (% of GDP)6
The Bahamas15025170405115.80.460.8
Barbados19012980404399.90.6103.8
Belize59--593.32.678.1
Guyana1351105202708.44.470.2
Jamaica400280601208606.20.1127.7
Suriname10022345103787.53.836.9
ECCU421304519.81.282.9
Antigua and Barbuda425473.71.2101.9
Dominica5255710.62.479.4
Grenada885939.70.790.3
St. Kitts and Nevis8759210.32.066.3
St. Lucia665714.91.182.6
St. Vincent and the Grenadines8759212.01.077.0
Region Total9751,0526812602,9686.91.980.0
Sources: Inter-American Development Bank (IDB); and IMF staff estimates.Note: ECCU = Eastern Caribbean Currency Union.

Includes cost of building new capacity of natural gas-fired power plants. IDB estimates do not include expansions for generation capacity in Belize, which imports a significant share of its electric power from Mexico. For Guyana and Suriname, includes costs for rural electrification.

Includes estimated costs of converting existing plants to natural gas and the construction of regasification facilities.

Includes solar, hydro, wind, and waste-to-energy projects. For the ECCU, reflects cost for geothermal power development.

For Antigua and Barbuda, reflects cost estimates for solar and wind power penetration of 20 percent by 2020.

Includes cost for solar water heaters, grid loss reduction, street lighting retrofit, and smart fund for EE projects.

Based on 2015 estimates.

Sources: Inter-American Development Bank (IDB); and IMF staff estimates.Note: ECCU = Eastern Caribbean Currency Union.

Includes cost of building new capacity of natural gas-fired power plants. IDB estimates do not include expansions for generation capacity in Belize, which imports a significant share of its electric power from Mexico. For Guyana and Suriname, includes costs for rural electrification.

Includes estimated costs of converting existing plants to natural gas and the construction of regasification facilities.

Includes solar, hydro, wind, and waste-to-energy projects. For the ECCU, reflects cost for geothermal power development.

For Antigua and Barbuda, reflects cost estimates for solar and wind power penetration of 20 percent by 2020.

Includes cost for solar water heaters, grid loss reduction, street lighting retrofit, and smart fund for EE projects.

Based on 2015 estimates.

Effects of Energy Investment on Public Debt Sustainability23

The feasibility of public financing of energy investments depends on the magnitude of the investment, the cost of financing, the current level of public debt, and the availability of fiscal space. For countries with solid public finances, the envelope proposed above could be financed by the public sector without undermining debt sustainability. However, in several Caribbean countries, public finances remain under strain, limiting large energy infrastructure investments.

Public versus private financing24

The impact of the investment cost on public debt sustainability can be alleviated through higher private participation. To assess the impact of individual countries estimated investment needs on their public debt trajectories, two financing scenarios are compared with a baseline scenario based on IMF staff’s macro-framework assumptions made in 2016.

  • Scenario 1: The public sector fully finances the investment in energy infrastructure. This scenario assumes that major infrastructure investments shown in Table 13.5 are financed by the public sector through a 20-year commercial loan, disbursed over three years (2016–18).25
  • Scenario 2: The private sector undertakes 80 percent of the investment. This scenario assumes that a private sector partner will finance the bulk of the infrastructure projects, particularly those that lend themselves to a public-private partnership type setup, like the development of renewable or natural gas–fired power plants.

To the extent that energy investments improve growth, pressures on debt sustainability from financing them will wane. The model results for the elasticity of GDP to energy efficiency reviewed earlier in this chapter show that a 10 percent improvement in energy efficiency across the entire economy could increase the level of GDP by 2 percent in the long term.26 In addition, spending on energy investment has a short-term impact on growth through the direct expansion of aggregate demand. Earlier work by IMF staff on a sample of Caribbean countries estimates the cumulative public investment multiplier to be about 0.37 after four quarters (IMF 2013). Collectively, the impact of energy investments on growth is expected to improve the public debt ratio over the long term.

Planned investments and the size of the efficiency gains

The analysis in this chapter finds that net of debt service, estimated average cost savings from planned energy investments (Table 13.5) could improve operational efficiency in the region by more than 25 percent over a 20-year period (2019–38). The key findings include the following:

  • The largest cost savings accrue to countries where the introduction of natural gas is viable. The savings average about 35 percent of recent utility operating costs under the U.S. Energy Information Administration’s baseline projections for the prices of natural gas and distillate fuel oil.27
  • Countries where hydroelectric power capacity is significant, such as Belize and Suriname, will enjoy overall lower energy costs.
  • Under baseline energy price projections (2019–38), efficiency gains in ECCU countries average 19 percent.28 Moreover, future scaling-up of geothermal power development in countries with higher geothermal potential could result in lower generation costs, implying higher efficiency gains.

As stated earlier, the efficiency gains are expected to translate into long-term growth benefits. It was pointed out earlier that energy investments would increase efficiency, and the impact on growth is estimated using the model results of the elasticity of GDP to energy efficiency. The growth rate assumed for the long-term debt dynamics of Scenarios 1 and 2 presented in the next section has been augmented to reflect the improved power sector efficiency from the investments and the resulting improvements in energy efficiency (cost savings). The ultimate impact on growth will likely depend on how the efficiency gains are spread across the economy. This exercise assumes a pass-through of energy efficiency or cost savings to end users of about 50–60 percent to accommodate potential required return on capital to the investor (whether private or public). Hence, in ECCU countries, where efficiency gains under baseline assumptions averaged 19 percent, growth was enhanced to reflect a 10 percent efficiency gain passed on to end users. Higher pass-through of cost savings could possibly result in higher growth dividends in the long term.29

Results of the Debt Sustainability Analysis

Although results differ by country, there are important general conclusions:

  • The magnitude of proposed energy investments does not materially alter the trajectory of public debt in most countries (Scenario 1). Although undertaking the investment through the public sector increased the public debt ratio for all countries over the medium term, the modeled cost recovery for debt service and the positive impact on growth (from both the investment impact and the lower energy costs) offset this increase in the long term.
  • Private sector financing of energy projects moderately improves the debt-to-GDP ratio compared with the baseline (Scenario 2). This result, however, is likely to be contingent on the private sector developer passing a measurable share of the cost savings to end users. Retaining the bulk of the cost savings as returns on investment could limit the transmission of benefits to the wider economy and reduce projected growth dividends from the lower cost of energy. In this regard, power purchase agreements that provide for limited reductions in consumer tariff rates are unlikely to generate the anticipated improvements in cost competitiveness in Caribbean economies.30
  • The impact of the investment on the debt trajectory will be less favorable than modeled if the efficiency of public sector investment is low or the overall cost of capital for the private sector is high. The exercise assumes that the return on investment is the same whether it is undertaken by the public or private sector. If, however, public investment efficiency is low, resulting in lower rates of return than in the private sector, then debt accumulation would be higher. Alternatively, a higher cost of financing for the private sector than the public sector could raise the required rate of return for the project and lower the potential share of cost savings passed on to the end consumer, resulting in lower growth dividends.
  • Fiscal risks would be higher if the income stream of the power utility cannot be safeguarded. For example, administrative practices that dictate a specific tariff rate or limit its adjustment to allow for full cost recovery would pose significant risks to the financial position of the power utility and, ultimately, the budget, for state-owned power companies.31

Countries fall into three categories with respect to capacity to undertake these large-scale energy investments. See Figure 13.12 (ECCU countries) and Figure 13.13 (rest of the Caribbean).

  • Countries with a lower initial debt load and sustainable debt dynamics can reap the benefit of reducing energy costs without weakening fiscal or debt sustainability.
  • Countries with a high public debt load and unsustainable debt dynamics are not well-positioned to undertake such investments using public sector financing.
  • Countries undertaking significant adjustment to bring debt back to sustainable levels could elect to finance high-yielding investments under certain conditions.

Figure 13.12.Impact of Energy Investments on Debt Sustainability1

Source: Mclntyre and others (2016).

1 Reflects IMF staff macroeconomic assumptions as of the end of October 2015.

Figure 13.13.Impact of Energy Investments on Debt Sustainability12

Source: Mclntyre and others (2016).

1 Reflects IMF staff macroeconomic assumptions as of the end of October 2015.

2 Does not fully reflect debt of state-owned enterprises for The Bahamas, Barbados, and Jamaica.

A Sustainable Private Investment Framework in the Energy Sector

Given public financing constraints, private investment may be pivotal for successful energy sector reform. However, public-private partnerships (PPPs) have been slow to take off in the Caribbean, and an important contributing factor has been the absence of appropriate PPP institutional arrangements and legislation. The status of energy PPP development is uneven. In some countries, such as Belize (Figure 13.14), the private sector is actively involved in electricity infrastructure investments. In others, such as Guyana and Grenada, the size of energy sector PPPs is quite limited.

Figure 13.14.PPP investments in the Energy Sector

(Average percent of GDP, 1990–2013)

Source: World Bank Public-Private Partnership Database.

Note: Lao P.D.R., a large outlier at 7.9, was excluded to show scale. PPP = public-private partnership.

Despite their prospective benefits, PPPs often carry significant risks. Compared with traditional procurement, the involvement of private partners increases the complexity of PPP contracts. This complexity calls for a strong institutional framework with appropriate supervision and safeguards, including to protect against risks from a power purchase agreement. These risks could arise from potentially lax selection standards, lack of transparency or sufficient competition in the bidding process, and inadequate risk sharing and risk transfer in the project design.

Successful institutional frameworks for PPPs include the following key elements:

  • A predictable, low-risk policy and regulatory environment. A strong policy and regulatory environment would ensure a level playing field across all energy sector investors and participants, including state-owned utilities, and would provide long-term clarity about the future of power sector regulation, without providing undue concessions to the private sector players.32
  • A clearly defined energy sector strategy. A long-term vision for the direction of the power sector, including targets for energy source diversification and the scope and process for private sector participation, backed up by specific policies such as the announcement of standard guidelines on power purchase agreements, will serve to assure the private sector of the government’s commitment to a transparent process and will make it easier to secure project financing.
  • An accommodating legal framework. Where a legislative framework is absent or deficient, governments should consider drafting a dedicated energy sector law—with possible technical assistance from international financial institutions—that recognizes the country’s renewable energy resource, if any, as a national resource and defines the terms and restrictions of permits, licenses, and concessions to private sector developers.
  • Sufficient institutional capacity and human resources within the government. PPP projects tend to be larger and more complex than traditional procurement, and thus require significant resources and expertise from the government in establishing PPP policies, identifying and evaluating projects, negotiating with private partners, and monitoring project execution.33

Conclusion

Estimates in this chapter support the view that cutting Caribbean energy costs could materially improve the region’s macroeconomic performance. Empirical analysis suggests that oil price movements influence real growth and the real exchange rate. Strategies to reduce exposure to oil price movements can help improve growth and competitiveness over the short and medium term, and alleviate pressures on the region’s external accounts. In the long term, improvements in energy efficiency are shown to support higher sustainable growth. Hence, measures to conserve energy and to diversify the energy mix toward cheaper sources should be a high priority for regional reform efforts.

Most of the building blocks for substantial energy reform are present in the region, but important deficiencies still exist in regulation. Establishing clear licensing and operational procedures for independent power producers, including the introduction of feed-in tariffs and net billing schemes, are key reforms. Establishing independent energy regulators in the region with the appropriate institutional capacity is also crucial to providing a low-risk, predictable environment for private energy sector investors.

Achieving targets already set in national and regional energy sector strategies would generate valuable savings but require strong commitments by national authorities and substantial investments in the power sector. Implementing these targets for renewable energy penetration and boosting energy efficiency could generate significant cost savings by lowering electricity tariffs and fuel import costs. However, announced targets are ambitious, and strategies have yet to specify the magnitude of investments and identify the potential sources of financing required for their implementation.

Augmenting the IMF staffs Debt Sustainability Analysis of individual Caribbean economies with IDB-based estimates of energy investment needs would not materially alter the public debt trajectory of most countries. However, countries with unsustainable baseline debt paths or acute fiscal vulnerabilities are not well-positioned to finance significant investments using public resources. In addition, countries where structural conditions are weak, characterized by low returns on public capital, low public investment efficiency, and low user-fee collection rates, are likely to face higher risks to fiscal and debt sustainability from large-scale public sector energy investments. The analysis also suggests that private sector financing of investments can significantly improve the public debt path over the long term through their potential growth-enhancing impact, if a measurable share of the cost savings is passed on to the rest of the economy.

Finally, Caribbean authorities are encouraged to pursue private financing of energy investments, particularly in projects that involve significant upfront capital injection. PPPs are one modality for private sector participation; however, strong institutional arrangements and an appropriate legislative framework are crucial to ensuring successful implementation in line with best practices and to limit contingent liability risks to the fiscal sector, including those related to the specific terms of the power purchase agreement.

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This chapter draws on McIntyre and others (2016).

1

Per World Bank indicators, Caribbean countries have, on average, electrification rates that exceed 90 percent.

2

Suriname is the second-largest oil producer in the region after Trinidad and Tobago but remains a net importer of petroleum products. Limited (though growing) refinery capacity explains Suriname’s significant imports of refined petroleum products.

3

Primary energy refers to energy from all sources in its crude form before any transformation.

4

Jamaica has recently increased its natural gas capacity, thereby reducing its dependence on imported oil from 97 percent to about 80 percent; additional capacity planned to come on stream by 2019 is expected to reduce dependence on oil further, to 60 percent. The text chart reflects data for the region to 2013.

5

After Trinidad and Tobago, in the Caribbean the Dominican Republic has the second-largest share of natural gas–fired power plants, representing about 20 percent of installed generation capacity.

6

This issue is dealt with in the discussion on regulatory reforms.

7

The LA6 comprise Brazil, Chile, Colombia, Mexico, Peru, and Uruguay.

8

In the Eastern Caribbean Currency Union (with a fixed exchange rate), core inflation peaked at 4.7 percent year over year in November 2008, after oil prices surged to a record high of US$145 per barrel in July 2008. In Jamaica, headline and core inflation also reached all-time highs of 25.6 percent year over year and 15.8 percent year over year, respectively, in July 2008. In Suriname, core inflation largely traced oil price swings, partly reflecting the automatic pass-through system of retail fuel prices in place since 2005; also, the authorities raised the fuel tax by about 70 percent in January 2011, which, along with a 20 percent devaluation of the official exchange rate, led to an increase of about 40 percent in fuel prices at the pump.

10

In the short and medium terms, the impact of higher oil prices on real GDP growth and the real exchange rate of Caribbean economies is estimated with a vector autoregression model with block exogeneity restrictions in line with the spillover effects literature. See Cashin and Sosa (2013) and Osterholm and Zettelmeyer (2008).

11

The results are comparable with those for other Latin American countries, such as Chile and Guatemala.

12

These results are based on elasticities derived from impulse response functions.

13

The role of energy consumption and efficiency in determining long-term output is estimated using the augmented mean group estimator (McIntyre and others 2016).

14

Energy efficiency is defined as energy consumption per unit of GDP. This follows a large body of analytical studies focusing on the link between energy and growth that has led to the energy consumption–GDP nexus (McIntyre and others 2016).

15

This estimate is based on capital formation in all sectors, not only in the energy sector.

16

The CARICOM Energy Policy (CEP), complemented by an action plan in the Caribbean Sustainable Energy Roadmap and Strategy (C-SERMS) Phase 10.

17

The targets comprise a 33 percent reduction in energy intensity by 2027; 20 percent renewable power capacity by 2017 (currently at about 15 percent); and carbon dioxide emissions reductions of 18 percent by 2017, 32 percent by 2022, and 46 percent by 2027 (see CARICOM Energy Policy 2013).

18

Net metering is a billing mechanism that credits renewable energy owners for the electricity they add to the grid. For example, if a residential customer has a solar system on the home’s rooftop, it may generate more electricity than the home uses during daylight hours.

19

Based on the CHENACT (2012) study based on data from Barbados, air-conditioning alone accounts for 48 percent of total electric consumption by hotels (Figure 13.2).

20

McIntyre and others (2016, Figure 4) present estimates that show similar positive impacts for other CARICOM countries achieving energy-efficiency targets—lower oil imports, decline in the national energy bill, and a positive long-term impact on the level of GDP.

21

McIntyre and others (2016) show that achieving individual country renewable energy targets would lower the national electricity bill and fuel imports.

22

Investments for new plant and equipment cover projected needs through 2023.

23

See McIntyre and others (2016) for the technical details of Scenario 1 and Scenario 2, efficiency gains under different price scenarios, and the translation of efficiency gains to growth benefits. The key findings are presented in this chapter.

24

This assessment considers only the cost of large infrastructure investments for natural gas and renewable power and excludes the cost of energy efficiency and conservation initiatives identified in Table 13.5.

25

Projects are assumed to be self-financing over the 20-year period 2019–38.

26

Based on our model that a 1 percent increase in energy efficiency would be accompanied by an increase in GDP per capita of 0.2 percent in the long term.

27

Cost savings are calculated as a percentage of historical average operating expense over the period 2012–15. Cost reductions may be lower if shown as a percentage of projected operating expenses that reflect a higher oil price.

28

Under lower oil prices than in the baseline, geothermal power provides negligible cost savings.

29

McIntyre and others (2016) show more formally that the trajectory of public debt would be governed by a debt dynamics equation augmented by the impact of energy investments on debt-service costs, growth, and the public sector primary balance.

30

However, under this scenario the country may still realize some benefits to the balance of payments by reducing the cost of imports of expensive fuel oil.

31

Also, a low collection rate on utility bills would negatively affect cash flow and debt-servicing capacity.

32

The UN-Energy report (2011) showed that the main contribution of government is creating a low-risk, predictable, and enabling political, legal, and regulatory environment with established electricity sector development goals.

33

Whatever the institutional arrangement created—an agency or unit—strong capacity will be critical to success, and this is an area in which Caribbean countries will require significant technical assistance.

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