In May this year the Bangladesh Power Development Board halted approvals for new power plants because those already being constructed will be able to meet demand until 2030. There are differing views on whether Bangladesh is facing a power glut, but the discussion highlights the risks faced by Chinese investors in overseas power projects.
Buoyant electricity demand has made South and Southeast Asia key markets for energy investments by Chinese firms – particularly in coal power. But after the rapid expansion of power plant construction, some countries are facing power surpluses, increasing market and policy uncertainties, or seeing the profitability of coal-fired power fall and the risk of stranded assets rise. Chinese firms and financial institutions investing in overseas coal power projects should therefore take a long-term view of the investment environment and proceed with caution.
Bangladesh: from power shortage to overcapacity
The Bangladeshi power sector has expanded rapidly. Generating capacity (including from captive power) leapt from 4,942 megawatts (MW) in 2009 to 13,885 MW in 2015. Yet as of June 2015, one quarter of the population still lacked access to electricity. To relieve power shortages, the government set a long-term goal of increasing capacity to 40,000 MW by 2030.
But an assessment by a high-level committee at the country’s ministry of power, energy and mineral resources found that demand for power in 2030 will only require 29,619 MW of generating capacity, assuming efficient use of installed capacity. Meanwhile, one third of the country’s generators currently lie idle, nationwide utilisation rates are low, and power firms are suffering losses.
The following three factors explain how Bangladesh has gone from suffering power shortages to risking a surplus:
1. Estimates of electricity demand were based on GDP targets, not actual figures
Bangladesh’s 2016 plan for power sector development used government-set GDP growth targets to estimate future demand. So a target of 7.4% annual GDP growth from 2016 to 2020, combined with longer-term development plans, resulted in estimated 2030 demand of 40,000 MW. This approach did not consider cyclical fluctuation (such as seasonal and daily changes) and ongoing falls in the energy-intensity of the Bangladeshi economy. The chair of Bangladeshi consulting firm Power Cell has suggested the industry considers realistic electricity demand and improves its methodologies.
2. Building new power plants has become a no-brainer
The Bangladeshi government wants to encourage investment in the power sector, and so has not included measures to increase competitiveness in its policies – leading to inefficient and disorderly expansion. The country’s power purchase agreements mean capacity charges are paid even when power plants are not generating. Also, the October 2010 Speedy Supply of Power and Energy Law gives government the power to bypass the usual open competitive bidding process and fast-track and simplify power plant approvals, as well as to give development rights directly to investors (including overseas investors) submitting unsolicited proposals. That law, a revision of which will remain in force until October 2021, slashed the time needed to win approval for energy and electricity projects. Research carried out in Bangladesh has found the law has encouraged construction of numerous small, expensive and inefficient oil-fired power plants, causing power prices to rise.
3. Existing capacity is underused
Oil-fired power makes up the bulk of generation capacity added over the past decade, with 80% of this being small 50-150 MW power plants. These smaller plants are inefficient and expensive. And with oil becoming more expensive and in short supply, some have not been running at full capacity, highlighting the price and supply risks faced by fossil fuel power generation.
The Bangladeshi government is aware of the financial and social risks arising from rapid and unplanned expansion. To avoid exacerbating power surpluses, a high-level committee of the ministry of power, energy and mineral resources has proposed that the country’s power sector adjust its future plans and halt approval of new projects. Any project not yet holding a Letter of Interest would likely be affected. Those involving foreign aid are less likely to be, due to the existence of governmental agreements.
Signs of power surpluses in other countries
Bangladesh is no isolated case. Initial estimates by Greenpeace, based on power and energy development plans, see a number of South and Southeast Asian nations at risk of power surpluses.
The Indonesian national power company, PLN, predicts annual growth in demand for electricity of 8.3% between 2017 and 2026, and has planned to expand capacity accordingly. But in reality, demand for electricity grew by only 3.1% in 2017. If PLN pushes ahead with its plans, the Java-Bali region will have a generation capacity 41% higher than peak demand, far higher than the Chinese industry standard of 20% to 30%. As a result, PLN reduced predicted annual growth for 2018-2027 to 6.9% and cancelled or delayed some projects, to reduce the risk of power surpluses.
Similar trends can be seen in Vietnam and Pakistan. Utilisation of coal power capacity in Vietnam is already at a historic low. Pakistan still suffers from power shortages, but IRENA predicts a reserve margin of 37% by 2020. The Pakistani government has already cancelled some unneeded coal power projects, including a Chinese one.
Risks for China’s overseas coal-power investments
Signs of surpluses are appearing in multiple energy markets around the world. Chinese companies and financial institutions can avoid potential losses by recognising that risk and adjusting investment plans accordingly.
Greenpeace figures show that China was involved in 18.4 GW of coal-fired power projects in Bangladesh as of May 2019 – accounting for 78% of the country’s expected total coal-fired power capacity in 2022.
China is making huge investments in coal-fired power in Bangladesh, mostly in the form of equity investments. In the past, Chinese firms tended to sign Engineering, Procurement and Construction (EPC) deals, which offered fixed returns if the plant was built and running on schedule. Equity investments go deeper, giving the Chinese firm a say in the running of the plant and a stake in long-term profits – but also mean longer-term risks. According to Greenpeace’s figures, 98% of Chinese coal-power projects in Bangladesh involve equity investments, and these are all already under construction, or in planning. Those in planning account for 76% of all equity investments. Information in the public domain does not allow for an estimate of how many of these Chinese-invested projects are at risk from the possible halting of approvals, but the risks to power investors of future surpluses in Bangladesh should not be underestimated.
In policy terms, independent power producers enjoy security of income, thanks to Bangladesh’s capacity charges and incentive mechanisms. At the same time, electricity subsidies paid to producers ensure domestic users pay only affordable prices for power. But if Bangladesh sees power surpluses in the future, subsidy-reliant generation will even drain government and grid coffers, and it is likely the government may not pay electricity tariffs as promised, leaving investors struggling to make their expected returns.
With Chinese firms becoming more involved in overseas coal power projects, investors should take long-term overcapacity risks seriously. To avoid entering the market blindly, they should assess future demand, energy development plans and policy stability. Meanwhile, other stakeholders such as banks and insurance companies involved in investments should improve their ability to understand and carry out risk analyses; give greater consideration to energy plans, power policy, energy transitions and environmental constraints in the host nation; identify high-risk projects and not fund or underwrite these any more.