Proceedings of the 23rd World Energy Congress 2016 RESEARCH PAPERS
In Support of a Market Mechanism for Energy Efficiency to Address Energy Trilemma: Bangladesh Context
Shafiqul Alam1 1
Advisor, Sustainable Energy for Development Programme, GIZ Bangladesh
[email protected]
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Abstract Bangladesh is one of the bottom-most countries in the global energy trilemma index due to ever increasing energy security concern, lack of energy access and problem with environmental sustainability. The growing pressure of economic growth seems to deteriorate the situation further. Since renewable energy is more specifically targeted for the rural off-grid as well as remote areas and industrial sector is the largest energy consumer in the country, industrial energy efficiency is the area that needs to be harnessed to address energy trilemma. Although the low cost fund is available, it has not been able to deliver the desired results in energy efficiency. Apart from low cost fund, the energy efficiency conservation and master plan of Bangladesh has proposed two other incentives, such as, subsidy and tax exemption/rebate, which are yet to be in practice. This paper, based on existing policies and literature, has identified that proper incentive mechanism is required to implement the energy efficiency target successfully. Firms cannot reduce energy consumption if their marginal benefit (MB) is less than marginal abatement cost (MAC) and efficient level of energy efficiency is achieved at the point where MAC and MB curves intersect. Since slopes of MAC and MB curves vary among the firms even within an industrial sector, different firms can reduce different amount of energy consumptions efficiently. The paper has also looked into different instruments, i.e., command and control and market mechanisms, to address the challenges of energy efficiency implementation. In command and control system, some firms would be able to comply if benefit outstrips cost but others would not. In a tax-based market mechanism, some firms might pay only tax instead of reducing energy consumption. However, a trading based market mechanism would allow the firms to trade “energy savings” among them in a way that the high achieving firms would sell their savings to the under achievers at a price agreed in the market and therefore, all firms would be able to comply with the target. Through trading, Pareto Improvement would be achieved as the firms would be better off and no one would be worse off. Moreover, in a trading system, firms have the incentive to identify innovative ways to reduce energy consumption beyond the target as opposed to the command and control but it needs to be carefully designed with strong Monitoring, Reporting and Verification (MRV) system. The trading based system seems to be more appropriate for Bangladesh to achieve its target of energy efficiency and thereby reduce gap between energy supply and demand with emission reduction. Energy saved in industries would become available for other energy starved sectors. All these would help improve the country in energy trilemma index. Keywords: market mechanism, energy trilemma, energy efficiency, marginal abatement cost, marginal benefit
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1. INTRODUCTION Bangladesh has been ranked as 113th among 130 countries in global energy trilemma index, which is measured on three parameters, i.e., energy security, energy equity and environmental sustainability [1]. Although scoring in environmental sustainability is better as the national grid is still very much clean on account of predominance of natural gas, the other two parameters are at risky positions due to energy insecurity resulting from increasing gap between demand for and supply of energy and absence of energy equity resulting from lack of energy access in many areas. Bangladesh has been historically less energy consuming as well as energy starved. Yet the country has seen remarkable progress during last decade with GDP growth hovering around 6% and has, of late, become a lower middle income country [2]. Over the last few years, overall energy consumption has increased significantly as a result of economic growth. This is expected to further increase in the coming years as the country has aimed at becoming a middle income country by 2021 [3]. To propel the country in the path of economic progress, which depends on utilization of energy at every level, concerted and successful attempt is needed. It is also required to ensure energy for all. This seems to be a mammoth task considering the level of access to electricity in the country. Moreover, energy is being used inefficiently in Bangladesh due to low and subsidized prices [4]. Under such circumstances, a prudent management of energy use through energy efficiency, renewable energy and energy from fossil fuel is necessary. Although Bangladesh has seen some progress in providing electricity access in remote areas, where grid connection is highly unlikely in the foreseeable future, through renewable energy, energy efficiency is yet to be explored significantly. Since industrial sector consumes approximately 50% of the country’s total energy and is likely to remain the largest energy consuming sector, this paper, based on existing policies of Bangladesh and literatures, investigates the reasons behind low uptake of energy efficiency at industrial level and necessity of designing a market mechanism to harness full potential of energy efficiency to improve the country’s position in the energy trilemma index.
2. PRESENT AND PROJECTED ENERGY SCENARIO During last several years, the installed capacity of power generation has been increased significantly. However, it is being achieved through a quick-fix strategy, i.e., installation of quick rental and rental power plants for a period of 3-15 years, and at the beginning, these oil-based plants were affecting economy negatively with a constant pressure of oil import and resulting drainage of foreign currency. The problem was further exacerbated due to generation of negative revenue from quick rental and
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rental power plants as a result of high generation cost and very low tariff at consumer level. In response to the crushing burden of these plants, the government had to increase the tariff of electricity and all types of fossil fuels in quick succession. Yet, some of these plants were forced to keep closed to avoid huge operational loss. As the oil price in the international market fell significantly, the loss on account of power generation from rental sources started to reduce. Stil the power generation system cannot be said secured as 29.43% of the total generation is based on imported oil [5]. Due to increased import of oil, the gap between demand for and supply of primary energy is widening. The gap has been sharply increasing from 2009-10 as shown in the beolw figure.
Fig. 1 Demand-supply gap of primary energy [6] With increasing electricity generation capacity, 76% people have access to electricity now [7] but still a significant portion of the total population is not connected to grid. Government has planned to ensure electricity for all by 2021. Taking this into consideration and to meet the growing need of economy, the Power System Master Plan (PSMP) 2010, under government policy scenario, has projected a demand for 33,708 MW of electricity by 2030, more than two times compared to present generation [8]. The proposition seems to be unsustainable considering over reliance on coal to generate 50% of total electricity in 2030 as shown below (Fig. 2). Since national coal mining policy is not finalized and the local stock of coal would not be sufficient to fulfill the demand, major portion of the coal is assumed to be imported. This eventually poses a serious threat to implement the plan. Due to increasing pressure of import, the foreign currency reserve would be heavily affected. Moreover, if the projected plan is carefully observed, the new power plants from 2021 to 2030 would be mainly coal based where as use of local gas would remain almost steady. The national grid, which is as of now very clean compared to many countries, would become extremely polluted. Additionally,
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imported liquefied natural gas (LNG) based generation is also planned from 2023, which would put added pressure on the foreign currency reserve.
Fig. 2 Electricity Demand Projection for 2030 under government policy scenario [8]
3. NATIONAL ALTERNATIVE ENERGY POLICIES AND PRESENT STATUS On the one hand, the government has taken steps to increase power generation and energy supply through using fossil fuels and on the other, it has developed relevant policies to foster renewable energy and energy efficiency in the country. The renewable energy policy 2008 states a target of ensuring 5% and 10% energy supply through renewable sources by 2015 and 2020 respectively [9]. In a comparable manner, the sixth five year plan of the government aimed at achieving 10% energy efficiency by 2015 [10] and the target has been revised as 15% and 20% by 2021 and 2030 respectively. In quantified form, the energy saving by 2030 is estimated to be in the order of 8,000 MW of which a mjor portion would be from industrial sector as it is the largest energy consumer [6]. The energy to be saved from industries would be available for providing access to energy starved sectors and consumers and this would help reduce the necessity of generating more electricity from polluting coal. Therefore, the environmental sustainability index would be improved. Now, if the present implementation status of the policies are comapred, renewable energy policy can be treated as successful to some extent as it contributes 2.97% to the national power supply including grid and off-grid connections [11]. However, despite having the low cost fund available in the financial market, investment on energy efficiency is very low. A report of the Central Bank of
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Bangladesh states a mere 4% of the green fund has been utilized for energy efficiency excluding the investment on new efficient brick kilns. On the other hand, investment on renewable energy is 21.7% of the green fund [12]. It clearly shows that investors are less interested in energy efficiency compared to the renewable energy.
4. REASONS BEHIND LOW UPTAKE OF ENERGY EFFICIENCY Despite having benefits, including cost savings and carbon emission reduction, investment on energy efficiency is far below than the optimal level. The Tetra Tech study (2014) identified several barriers to adoption of industrial energy efficiency in Bangladesh, broadly categorized as: (i) incentive problem, (ii) information barrier, (iii) behavioral problem and (iv) financial market problem. Low energy price creates incentive problem as it reduces viability of energy efficiency projects. Information barrier includes lack of knowledge and awareness on benefits of energy efficient investment and lack of familiarity with energy efficient technologies. Behavioral problems are perceived risk of loss of production in case of investment in energy efficiency and different priorities that compete in taking decision on new investment and development etc. High transaction cost and perceived risk of financial institutions in energy efficiency financing are financial market problem [4]. Further, a UNEP study (2006) categorized barriers of energy efficiency in Bangladesh as: (i) lack of awareness about value of energy savings, (ii) absence of technical know-how of energy efficient technologies, (iii) lack of corporate social responsibility in terms of energy misuse and associated pollution, (iv) access to finance barrier, (v) ineffective government policies and lack of incentive. Of the five barriers, lack of incentive has been identified as the main problem [13]. In behavioral context, prospect theory of decision making under risks can be cited in case of energy efficiency. Consumers are risk averse and they compare the chance of gaining benefit and possibility of losing from investment on energy efficiency with performance, which is ensured, under no investment on energy efficiency, i.e., business-as-usual case [14]. Since consumers consider the welfare gain and loss of such investment with business-as-usual scenario, the percieved risk of such investment results in status-quo, i.e., no investment of energy efficiency. This also stems from lack of incentive. On the other hand, the energy efficiency and conservation master plan of Bangladesh has given indication of incentives in three forms, i.e., (i) subsidies for energy efficient facilities and equipments, (ii) preferential taxation, tax reduction, exemption or accelerated depreciation and (iii) low cost fund
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[6]. Of the three options, only the low cost fund is available in the market but it is not fulfilling the objective. Therefore, it is being observed that the absence of proper incentive mechanism is the major reason behind implementation of industrial energy efficiency in Bangladesh.
5. MARKET MECHANISM TO ADDRESS ENERGY EFFICIENCY CHALLENGES Historically, different tools, such as, command and control and market mechanisms are used in removing environmental externalities. These tools may also be used in achieving the target of energy efficiency. However, before doing so, it is necessary to understand how energy consumption can be reduced. Generally, firms can reduce energy consumption in two ways, i.e., (i) reducing output and (ii) changing inefficient technologies. Since production cost would be increased and business competitiveness would be decreased, reducing output is not a viable option. Other option, i.e., changing inefficient technologies with the efficient ones depends on cost-benefit assessment of investment on new technology. Suppose, two firms of same energy consumption of 30 ton oil equivalent (toe) per annum have identified energy efficiency options and calculated required investment for the measures. The economically efficient point of energy efficiency would be achieved where marginal abatement cost (MAC) and marginal benefit (MB) curves intersect. Taking all these into considerations, x* and y* are the efficient points for firm1 and firm2 with energy efficiency potential of 10toe and 20toe respectively (Fig. 3). Since MAC and MB curves for firm1 are steeper than those of firm2, firm1 has less energy saving potential in a viable way than Firm2.
Fig. 3 Efficient level of energy efficiency potential of two hypothetical firms
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Now, if command and control is applied with a target of 15toe energy saving through energy efficiency for individual firms, firm2 would be able to achieve the target easily but firm1 would face difficulty as it cannot reduce consumption beyond 10toe in a feasible way. One of the reasons behind firm1’s low level of reduction can be it is already using more efficient technology compared to Firm2. If firm1 is forced by the Regulator to increase energy efficiency beyond its efficient point to meet the target, the firm will incur loss due to the gap between marginal abatement cost and marginal benefit as shown below. On the other hand, if a market mechanism, such as, cap and trade, with a cap of maximum 30toe energy consumption by the two firms is set, firm1 will directly reduce 10toe against its obligation of 15toe as up to 10toe reduction, MAC1 is less than price for firm1 and beyond that point, price is higher than MAC1 (Fig. 4). Conversely, firm2 would have the capacity to reduce up to 20toe against obligation of 15toe reduction as its MAC2 is below the equilibrium price up to this point and therefore, it would have the luxury to sell 5toe to firm1. But the overall energy consumption would be limited to 30toe.
Fig. 4 Possible trading of energy savings between two hypothetical firms The scenarios, as shown above, indicate that in case of command and control, there is chance of noncompliance by firm1 simply because of economic reasons, i.e., absence of incentive. On the other hand, trading would make both firms better off as firm1 would be able to comply with the target by purchasing part of its obligation from energy saved by firm2, which would receive economic incentive from firm1 for trading “energy savings” over and above its target. In this case, Pareto
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improvement is achieved as no party is worse off because of trading but both are better off compared to their previous situation. Since there is incentive in a cap and trade system, firms would have the motivation to generate innovative solutions to reduce their energy consumption beyond the target set by the Regulator. This would help leverage private investment in industrial energy efficiency and more importantly in research and development (R&D) to increase competitiveness. But in command and control, there is no incentive to go beyond the regulation and there is a fear that if companies comply under command and control, stringent regulation with increased target might come in future. Another market based mechanism, i.e., tax, is used in emission reduction with the option for charging the polluter for each unit of emission where tax ensures price certainty instead of certainty in quantity of emission reduction as some industries might accept the tax and pay without reducing emission [15]. Industries might do same thing in energy efficiency by paying tax instead of reducing consumption. On the other hand, subsidy system and tax rebate/exemption for energy efficient equipment, as proposed in the master plan, are short term measures. Furthermore, subsidy system needs to be carefully studied as energy is highly subsidized in the country and it is one of the major reasons behind widespread misuse of energy in the country. In light of these, a trading based mechanism seems to remove the challenges of implementing industrial energy efficiency in Bangladesh but a strong monitoring, reporting and verification (MRV) system needs to be designed for proper monitoring and reporting of periodic energy savings of individual industry. Organization shall develop own monitoring mechanism to record energy consumption of different components of the industry on a regular basis, compare the same with the baseline scenario and produce the energy savings report periodically. A third party verification system is necessary to be put in place to verify the energy savings claimed in the report. The complete MRV mechanism would ensure transparency, consistency, accuracy and accountability so that industries remain transparent and the verifiers remain accountable on their verification. It would also help reduce the chance of double counting and data misrepresentation. If applied successfully, MRV would become the base of trading energy savings but would increase the cost of industry as well. Any laxity on MRV system may lead to a failure of trading based mechanism. Apart from these, intensive and inclusive stakeholder consultations as well as capacity development are required for both government and private sectors for successful implementation of a trading based mechanism. These would involve cost.
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One aspect that shall also be taken into consideration is that, due to easy and cheap trading; some energy intensive industries might only depend on trading instead of reducing their own energy consumption. The MRV system would help identify the industries that only depend on trading and to address this, the target for energy efficiency might need to be reviewed periodically. Another aspect, i.e., leakage, which is a possibility in case of emission trading due to shifting of polluting industry to other country, may not be applicable for industrial energy efficiency in Bangladesh context as energy price is comparatively higher in other countries.
6. CONCLUSION Harnessing the full potential of energy efficiency to address the energy trilemma problem needs to be supported by an instrument that provides incentive for the industries and also ensures reduction in energy consumption based on the target provided by the government. Since there is incentive problem in case of command and control and uncertainty over quantity of energy consumption reduction in a tax system, a trading based market mechanism, i.e., cap and trade system, seems more appropriate for Bangladesh. If a firm reduces energy consumption by more than the target, a “certificate of energy savings” of the excess amount would be issued in favor of the firm. The firm would sell it to other firm, which is unable to meet its target, at an agreed price. The price of such trading would be determined by supply-demand of such certificates. This, in turn, would expedite the process of achieving government’s energy efficiency target. However, before introducing such a system, benchmarking of different industrial sectors, for example, steel, cement, ceramics, textile, chemical, brick kiln etc., would be required and large energy consumers/designated consumers need to be identified. In addition, a national registry system shall be developed to ensure accounting of energy savings and to identify the industries that are under compliance and non-compliance. In this regard, the MRV system is extremely important to ensure compliance and successful trading between high achievers and under achievers in terms of energy efficiency. High price volatility of “certificate of energy savings” is also a possibility that needs to be taken care of through supply-demand management and adjustment of energy efficiency target.
7. REFERENCES [1] World Energy Council. 2015. 2015 Energy Trilemma Index, London. [2] World Bank. 2016. Retrieved on May 27, 2016, http://beta.data.worldbank.org/country/bangladesh?view=chart
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[3] Planning Commission. 2012. Perspective Plan of Bangladesh 2010-2021: Making Vision 2021 a Reality. General Economics Division, Planning Commission, Government of the People’s Republic of Bangladesh, Dhaka. [4] Tetra Tech Es, Inc. 2014. Industrial Energy Efficiency Opportunities and Challenges in Bangladesh – Final Report, New Delhi, India. [5] Bangladesh Power Development Board. 2016. Retrieved on May 25, 2016, http://www.bpdb.gov.bd/bpdb/index.php?option=com_content&view= article&id=5&Itemid=6 [6] Sustainable and Renewable Energy Development Authority (SREDA) and Power Division. 2015. Energy Efficiency and Conservation Master Plan up to 2030. Ministry of Power, Energy and Mineral Resources, Government of the People’s Republic of Bangladesh, Dhaka. [7] Bangladesh Power Cell. 2016. Retrieved on May 25, 2016, http://www.powercell.gov.bd/site/page/d730f98d-8912-47a2-8a35-382c4935eddc/Power-Sectorat-a-glance [8] Power Division. 2011. Power System Master Plan 2010. Power Division, Ministry of Power, Energy and Mineral Resources, Government of the People’s Republic of Bangladesh, Dhaka. [9] Power Division. 2008. Renewable Energy Policy of Bangladesh. Power Division, Ministry of Power, Energy and Mineral Resources, Government of the People’s Republic of Bangladesh, Dhaka. [10] Planning Commission. 2011. Sixth Five Year Plan FY2011-2015: Accelerating Growth and Reducing Poverty, Part 2: Sectoral Strategies, Programmes and Policies. General Economics Division, Planning Commission, Government of the People’s Republic of Bangladesh, Dhaka. [11] SREDA. 2016. Retrieved on May 27, 2016, http://www.sreda.gov.bd/index.php/site/page/ [12] Sustainable Finance Department. 2015. Quarterly Review Report on Green Banking Activities of Banks & Financial Institutions and Green Refinance Activities of Bangladesh Bank, July-September 2015. Sustainable Finance Department, Bangladesh Bank, Head Office, Dhaka. [13] UNEP. 2006. Barriers to Energy Efficiency in Industry in Asia – Review and Policy Guidance. Retrieved on May 20, 2016, http://www.energyefficiencyasia.org/docs/Barriers%20to%20Energy%20Efficiency%20review %20and%20policy%20guidance.pdf [14] Daniel, K. and Amos, T. 1979. Prospect Theory: An Analysis of Decision Under Risk. Econometrica, 47(2), pp. 263-291. [15] Center for Climate and Energy Solutions. 2011. Climate Change 101: Cap and Trade, Arlington.
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