New government sets out to rejuvenate Sri Lanka’s energy and utilities

In a manifesto released in the run-up to Sri Lanka’s 2015 presidential election, Maithripala Sirisena, the then-presidential candidate for the New Democratic Front party, put energy sector reform at the top of the agenda, noting that “energy constitutes one of the foremost factors deciding the future of the country”. Since winning the election, Sirisena’s government has followed up on this campaign promise.

In 2015 and early 2016 the state rolled out a series of reforms and initiatives aimed at shoring up the country’s energy industry, including expanding the national electricity grid, particularly in rural areas; developing new renewable energy sources; opening up the hydrocarbons sector to greater foreign investment; and working to introduce a new fuel pricing formula, which has the potential to improve the economics of the domestic energy business dramatically.

These and other changes have been put forward as part of a sector development plan covering 2015-25 conceived by the Ministry of Power and Energy (MoPE). Along with a number of additional medium-and long-term strategies for the sector – such as the long-term expansion plan of the Ceylon Electricity Board (CEB) for 2015-34 – the MoPE’s efforts are expected to contribute to an uptick in energy sector investment in Sri Lanka. Indeed, the 2015-25 plan is a key step towards achieving the government’s objective of 100% energy self-sufficiency by 2030.

Overcoming Obstacles

However, a variety of hurdles stand in the way of the state’s realisation of this aim. While the current government has worked to attract private sector players to participate in various segments, the energy sector as a whole remains largely concentrated in a handful of major state-controlled enterprises. The publicly owned CEB controls the majority of the nation’s power segment, accounting for some 66% of electricity generation and upwards of 90% of the country’s transmission infrastructure. Similarly, as of early 2016 the publicly held Ceylon Petroleum Corporation (CPC) owned and operated Sri Lanka’s sole oil refinery.

The Future

Though the government is pushing for the rapid development of wind, solar, small-scale hydro and other renewables, the segment is expected to grow slowly in the coming years, due to the relatively high cost of installation and operation compared to traditional methods of power generation. The CEB reports that coal, gas, oil and hydropower are expected to account for the bulk of Sri Lanka’s generation mix for at least the next decade.

The Ministry of Petroleum Resources Development (MPRD) introduced a new fuel and energy pricing mechanism in early 2016 – designed to ensure that the cost of fuel in Sri Lanka better reflects international hydrocarbons prices, which have dropped dramatically since mid-2014 – but this instrument has since been delayed repeatedly by the Ministry of Finance (MoF). “One of the most pressing challenges currently facing this country is the lack of a pricing formula for the oil and gas sector,” Anuj Jain, the senior vice-president of finance at Lanka IOC, the only private hydrocarbons firm operating in Sri Lanka, told OBG. “Solving this is vital to the nation’s future.”

Despite these and other issues, most local players are relatively optimistic about the sector’s prospects in the coming years. Since the end of the Sri Lankan civil war in 2009, the country’s energy performance and energy sector outlook have improved considerably. The national power transmission grid currently serves more than 98% of the population. Generation by small-scale, independent wind, solar, thermal and hydro sources – which provide what is known in Sri Lanka as non-conventional renewable energy (NCRE) – has more than doubled in the past decade, from 5% of the overall generation mix in 2008 to around 11% by the end of 2015. Similarly, the departure in late 2015 of a major mining company – Cairn Lanka – from Sri Lanka’s offshore Mannar Basin, where the firm had been involved in hydrocarbons exploration since 2007, has left the government in a good position to invite new foreign oil majors to participate in the nation’s potential commercial oil and gas market. Finally, the state has taken an aggressive stance on issues related to energy conservation and environmental sustainability recently, with the MoPE announcing that as part of its 2015-25 plan it would reduce the energy sector’s carbon footprint by 5%. With this in mind, most market observers and participants agree that the future appears bright.

Looking Back

The history of energy in Sri Lanka dates back to the colonial period. In 1895 Bousted Brothers, a private colonial company, shipped diesel generators from England to the island nation and supplied electricity to a handful of mercantile firms in Fort Colombo. Less than a decade later a private firm was established to distribute electricity in the country. In 1905 central Kandy was lit by electric lights for the first time by the Kandy Lighting Company, a subsidiary of the Colombo Gas & Water Company. Seven years later D J Wimalasurendra, a Sri Lankan engineer who is known today as the “father of hydropower”, began to design the country’s first hydroelectric dam. It took him nine years to complete the project due to a lack of support from his superiors at the Department of Public Works. During the first half of the 20th century, the development of power projects in Sri Lanka took place largely as a result of Sri Lanka’s booming tea industry, which required small hydropower plants to power tea processing factories.

The colonial government established the nation’s first thermal power station in 1928. In 1935 the state established the Electricity Board of Ceylon – a predecessor to the modern CEB – though it was shut down again due to the outbreak of World War II. Three years after the war ended, Sri Lanka achieved independence. The new reconstituted CEB set out to install a national power system, expanding the existing grid dramatically and commissioning a number of new large-scale hydro and thermal power stations. During this period, tea factories across the country switched to grid power, as it was cheaper and more reliable than small hydropower. By the early 1980s, however, significant growth in demand had forced the CEB to use gas-driven turbines during periods of peak usage. The rising price of fuel imports led the government to raise grid electricity prices by 150% between the late 1970s and the early 1980s. Consequently, beginning in the 1980s Sri Lanka experienced a renewed interest in small hydropower plants, with the state and a handful of foreign non-governmental organisations working to revive this segment.

In the early 1990s small hydropower plants were connected to the national grid for the first time. This eventually led to the introduction in 1996 of new legislation that allowed private, small-scale power projects – defined as those with a generation capacity of 10 MW or less – to sell power to the CEB under standardised power purchase agreements (SPPAs). This policy is widely regarded as the basis for the success of Sri Lanka’s rapidly growing NCRE industry today. Under an SPPA, the CEB guarantees the purchase of all energy produced by a small-scale private operator, with no penalty for a lack of delivery from the facility. While this policy initially applied only to small hydropower projects, today it has been extended to wind, solar, wave and biomass – including agricultural, industrial and municipal waste energy, as well as energy from waste heat recovery – power plants.

The development of the national grid began in earnest after World War II and continued straight through the following half century, though the Sri Lankan civil war rendered large areas of the country off limits to development from the early 1980s through to the first decade of the 2000s. In the MoPE’s 2015-25 plan, which was released in mid-2015, the ministry reported that the country had achieved overall grid connectivity of 98% of Sri Lanka’s population, up from just 70% in 2005. One of the objectives of the plan is to extend the transmission grid to include the 126,000 rural homes that are currently not connected to the network.

Powering Policy

A variety of federal and regional entities are involved in managing, developing and regulating Sri Lanka’s energy sector and utilities supply. The Ministry of Power and Renewable Energy (MPRE), renamed from the former MoPE following parliamentary elections in late 2015, has a mandate to formulate and implement national power policies and related projects. The ministry is the top federal authority in terms of the development and operation of electricity infrastructure, including generation and transmission facilities. As such, the MPRE is responsible for guaranteeing energy security, extending rural electrification, promoting energy efficiency and boosting indigenous renewable energy sources. Under the 2015-25 sector development plan, the MoPE set “an ambitious goal of 100% energy self-sufficiency by 2030”, as stated by the former minister of power and energy, Patali Champika Ranawaka, in his introduction to the strategy.

Regulation

Two regulatory entities have domain over Sri Lanka’s power sector, namely the Public Utilities Commission of Sri Lanka (PUCSL) and the Sri Lanka Sustainable Energy Authority (SLSEA). The PUCSL, which was established by the PUCSL Act No. 35 of 2002, was initially responsible for regulating the operations of the electricity, water and petroleum sector. Under subsequent legislation – namely the Sri Lanka Electricity Act No. 20 of 2009 and a 2013 amendment to that act – the commission’s remit was curtailed slightly. As of 2015 the PUCSL’s role encompassed the “economic, technical and safety regulatory functions for the island’s electricity sector”, according to a recent policy document published by the entity. The PUCSL also plays an advisory role to the MPRE, and serves as a shadow regulator for Sri Lanka’s lubricants industry.

Meanwhile, the SLSEA, which was established by the SLSEA Act No. 35 of 2007, has a mandate to drive the development of sustainable, indigenous energy generation and usage. The authority operates with three overarching objectives in mind: ensuring Sri Lanka’s energy security, supporting and expanding the NCRE segment, and managing the growth of energy-intensive industry and other high-energy economic activities. These efforts are to ensure the long-term economic and environmental sustainability of the nation’s energy sector. Both the SLSEA and the PUCSL fall under or are overseen by the MPRE, but each regulator operates on an independent basis.

Oversight

Meanwhile, Sri Lanka’s upstream and downstream petroleum segment is overseen by the Ministry of Petroleum Resources Development (MPRD), which was established in 2005. In 2010 the ministry was replaced by a newly formed Ministry of Petroleum Industries, which took charge of downstream developments, while the country’s president at the time, Mahinda Rajapaksa, personally oversaw upstream activities. In late September 2015, however, the current government reverted to the earlier model, once again placing both upstream and downstream petroleum-related activities under the reconstituted MPRD. The ministry has a mandate to ensure that Sri Lanka can meet growing demand for fuel – primarily to power electricity generation – via imports and potentially, in the future, domestic production (see analysis). Additionally, the MPRD oversees four subsidiary entities: the CPC, Ceylon Petroleum Storage Terminals Limited (CPSTL), the Petroleum Resources Development Secretariat (PRDS) and Polipto Lanka, which is involved in developing new technologies to turn waste plastics into transport fuels. Prior to the opening up of the sector the CPC was the state-owned monopoly petroleum operator, while the CPSTL has a mandate for storing and distributing petroleum products. Finally, the PRDS, which was formed in 2003 prior to the establishment of the MPRD, is charged with industry oversight and planning.

Dominant Player

The power sector in Sri Lanka is composed of a mix of large, small, public and private entities. The MPRE oversees the publicly owned CEB, the current iteration of which was formally established in November 1969, though the board’s history goes back to the 1930s. The CEB is involved in power generation, transmission, distribution and revenue collection. In 2015 the CEB operated 23 power plants, which together generated 66% of the national grid’s installed capacity, according to data from the ADB. In conjunction with the MoF, the CEB is a controlling shareholder in the Lanka Electricity Company (LECO), a state-owned power distribution company that has been in operation since the early 1980s and primarily serves Sri Lanka’s western province, as well as Lanka Coal – a government venture to procure and supply coal for coal-fired thermal plants, with 60% ownership by CEB and 20% by the MoF.

As of the end of 2014 Sri Lanka’s total installed power generation capacity was 3.9 GW. CEB-owned and -operated facilities accounted for 2.8 GW – or nearly 72% – of this total, according to recent data from PUCSL. This included 17 commercial hydro-power plants with a total capacity of 1.38 GW, six oil-fired thermal power plants with a capacity of 533 MW each and one coal-fired thermal power plant – the Puttalam power plant in Norochcholai, whose first phase became operational in 2011 and third phase in 2014 – with a generation capacity of 900 MW. The Puttalam plant is the largest power plant in Sri Lanka and the first of a number of new coal-fired power plants currently in development under the CEB.

The CEB was responsible for just over 69% of total electricity generation in Sri Lanka in 2014, with private sector entities making up the rest. This represented a slight decline on the previous year, when CEB-owned facilities accounted for almost 74% of total generation. With regards to the way power generation is split, in 2014 the CEB’s hydropower plants contributed the most to Sri Lanka’s energy supply, generating 3649 GWh in total. The coal-fired Puttalam plant was the second-largest contributor, at 3202 GWh. Meanwhile, the CEB’s oil-fired power plants were responsible for contributing 1744 GWh to the grid over the course of the year, which was the fourth-largest generation mix component after private power plants, according to PUCSL data.

Key Contributors

While the CEB dominates all aspects of Sri Lanka’s power sector, various other public and private entities play an important role. LECO, which began operations in June 1984, serves as a power distributor to around 500,000 consumers in western Sri Lanka, between Galle and Negombo. The firm is also involved in maintenance and repair work on electricity infrastructure nationwide.

Reflecting the ever-increasing importance of coal for the energy mix, Lakvijaya Power Station is a 900-MW coal-fired station in the Puttalam District. It began operations in 2011 and is Sri Lanka’s first coal power plant. The Phase 1 and Phase 2 stages of the plant have been rolled out, with funding from the Export-Import Bank of China on a preferential loan of $1.35bn, which offered savings for the CEB, and boosted current wattage. The first phase of the plan injected 300 MW to the main grid, which amounts to 17% of the national power requirements of the country. The second phase is injecting another 600 MW. Despite some environmental concerns, this is a move to provide cheaper power to the country. Coal power generation increased substantially by 72.5% to 3328 GWh during the first eight months of 2015, reflecting the enhanced capacity of the plant.

By the end of 2014 Sri Lanka was home to seven independent power producers (IPPs), which are private firms involved in thermal electricity generation powered by either imported oil or combined-cycle technology, the latter of which makes use of both gas-and steam-powered turbines. According to PUCSL data, in 2014 the nation’s IPPs boasted an overall generation capacity of 672 MW, which was equal to just over 17% of Sri Lanka’s total generation capacity mix. Installed capacity aside, however, the same year IPPs were responsible for more than 21% of total electricity generation, up from 16.5% in 2013.

The largest IPP operator in Sri Lanka is West Coast Power, which was established in 2007 by a mix of private and state-owned entities to build, own and operate a 300-MW combined-cycle power plant at Kerawalapitiya, near Colombo, on Sri Lanka’s west coast. By 2014 the firm’s plant had a capacity of 270 MW, and it generated around 639 GWh in total over the course of the year. The nation’s second-largest IPP is AES Kelanitissa, which was a subsidiary of the US-based AES Corporation, one of the largest power companies in the world, until it was acquired by the Japan-based Sojitz Corporation in February 2016. The 168-MW combined-cycle AES Kelanitissa power station came online in 2003, and it has been operating in combined-cycle mode since 2005. In 2014 the plant generated nearly 488 GWh of electricity.

Renewables

As well as CEB-owned generation facilities and IPPs, a growing number of small-scale firms have set up various types of NCRE plants in recent years. By the end of 2014 the country’s NCRE generating mix – facilities with a capacity of 10 MW or less – was 442 MW in total, which was equal to 11.3% of Sri Lanka’s total installed power generation capacity. This total was made up primarily of small hydropower projects with a cumulative generation capacity of 293 MW altogether, followed by wind installations at 124 MW. The remaining 25 MW of capacity was made up of biomass and solar facilities.

This segment, which has been key since the mid1990s and received a new impetus in 2007 through the establishment of the SLSEA, has expanded rapidly in recent years. According to data from the CEB, by the end of 2015 Sri Lanka was home to 173 NCRE installations. This represented growth of more than 19% from the end of 2013, when there were 145 NCRE projects in operation. The 2015 figure is up 75% from 99 NCRE projects in 2010, and more than 260% from only 48 NCRE projects in 2006 (see analysis).

Growth Trend

Sri Lanka has seen a sharp rise in energy use and demand over the past decade, as well as the end of a long period of conflict and renewed economic activity across the country. Total energy generation increased 5.7% in first eight months of 2015, to 8675 GWh for this period. In 2014 per capita energy consumption was 535 KWh per person, up almost 30% from 412 KWh per person in 2009, according to PUCSL and CEB data. In 2014 around 45% of energy demand was from households, commercial facilities and related entities, while 29% derived from the transport industry (which exclusively uses liquid fuels) and 26% from industrial firms, according to data from the SLSEA. These figures have held relatively steady since 2009, though household and commercial consumption has seen energy consumption fall from 51% in 2009 to 45% in 2014.

According to data from the CEB and PUCSL, the country’s 2014 energy consumption comprised 4.8m tonnes of oil equivalent of biomass, 3.2m tonnes of oil equivalent of petroleum, 62,000 tonnes of oil equivalent of coal and 951,000 tonnes of oil equivalent of electricity. Electricity consumption in the domestic, industrial, general purpose (including government) and hotel sectors increased by 9.5 per cent, 3.8 per cent, 5.7 per cent and 10.0 per cent, respectively, during the first eight months of 2015, reflecting the continued growth of economic activity. Accordingly, the share of hydro, fuel oil, coal and NCRE power generation stood at 34%, 18%, 38% and 10%, respectively, and electricity consumption in the domestic, industrial, general purpose and hotel sectors increased by 9.5%, 3.8%, 5.7% and 10%, respectively, during the first eight months of 2015. With Sri Lanka’s economy forecast to continue to post strong figures for growth, demand for power of all kinds is widely expected to continue to expand apace across all segments.

Ambitious Plans Afoot

Meeting this rising demand while simultaneously building up the country’s indigenous, renewable energy segment is the overarching objective of the MoPE’s 2015-25 Energy Sector Development Plan for a Knowledge-based Economy. The plan aims to address a handful of key challenges in the energy sector, including Sri Lanka’s 100% dependency on imported oil for use in the transport segment, a lack of domestic energy research and development (R&D) activities, unsustainable consumption patterns, the high cost of producing electricity for the national grid, and bureaucratic issues related to the large number of public entities involved in the energy industry. A number of ambitious targets for 2025 and beyond were listed, including boosting the share of electricity generation from renewable sources from 50% in 2014 to 60% by 2020. This growth target encompasses generation from all hydropower plants – including large-scale commercial plants, which are not usually considered “renewable” – as well as biomass-fueled generation and traditional NCRE power sources. By 2025 the MoPE aims to have increased total electricity generation in the country to 6400 MW, from 4050 MW at the end of 2014; to meet 100% of the nation’s petroleum demand via domestic refining activities; and to have reduced the energy industry’s carbon footprint by 5%. To achieve these objectives, the 2015-25 plan includes eight “thrust areas”, each designed to tackle a separate issue. Under the first thrust area, the state aims to integrate the country’s national energy policy, while the second targets increased development and investment in green energy technologies. The third and fourth areas involve improving energy conservation and service improvements, respectively. The next two thrust areas include policy plans for developing new energy infrastructure and instituting good governance programmes among sector players. The final two areas aim to streamline financing in the sector and to ramp up R&D activities.

Boosting Ties

Under the CEB’s 2015-34 Generation Expansion Plan, which lays out the public firm’s long-term strategy to boost generation activities and is being amended with assistance from Japan’s International Cooperation Agency in 2016, Sri Lanka’s power grid could potentially become more closely integrated with its neighbours in South Asia. This follows a series of efforts by Sri Lanka’s government and the power sector to initiate a project to link the nation’s grid, which is relatively small by international standards, with India’s. In 2010 the governments of India and Sri Lanka signed a memorandum of understanding to carry out a joint feasibility study for the project, and while industry leaders widely believe in its technical merits, vested interests have contributed to reservations over the possibility of deepened integration with India. In late 2014 the member states of the South Asian Association for Regional Cooperation – an economic and political union comprising Sri Lanka, India, the Maldives, Nepal, Bhutan, Pakistan, Afghanistan and Bangladesh – agreed to a regional grid integration project. Technical and financial challenges persist, particularly with regard to Sri Lanka and the Maldives, which are the only two countries not currently linked up. “We have a very small grid compared to the US or Europe,” Ranawaka, the former minister of power and energy, told OBG. “When there are fluctuations there, they can be absorbed.” The India grid connection project would allow Sri Lanka’s grid to absorb such fluctuations.

Pricing Power

Another key issue the government was working to address in early 2016 involved the cost of power in Sri Lanka. In recent decades, ad hoc and politically motivated power tariff policy changes, which have been enacted with little regard for the actual price of energy in international markets or the cost of generating power domestically, have saddled the CEB with a significant amount of debt. In 2014 the publicly owned operator recorded operating losses of LKR11.7bn ($84.2m), although as a result of generation mix changes and lower power costs, this position has improved greatly in 2015, with the CEB reporting a profit of LKR22bn ($158.4m) and projecting a profit of LKR30bn ($216m). In 2009 the PUCSL set out to correct the tariff situation, instituting a new tariff methodology aimed at unbundling the rate of power generation, transmission and distribution, and hoping to effectively end a de facto subsidy on power costs. However, this plan was never fully implemented.

More recently, the CEB introduced a new time-ofuse (ToU) tariff on electricity consumption, which was approved by the PUCSL in late 2015. In recent years, mandatory ToU meters have been installed for industrial and general-purpose commercial consumers and expanding ToU meters to domestic users is also under consideration. Under the policy, the CEB charges different rates for electricity used during off-peak hours, day hours and peak evening hours. This was widely considered to be a major step towards rationalising the country’s power tariffs. By most accounts the sector has some way to go in this regard. As of early 2016 the PUCSL, the CEB and LECO were discussing rolling out ToU metering more broadly across different segments nationwide.

Petroleum Sector

One major contributing factor to the high price of electricity in Sri Lanka has been the nation’s steady shift to thermal power generation over the past two decades, which, along with rising demand for transport fuels, has necessitated a considerable increase in costly oil and gas imports. In 2015 around 25% of Sri Lanka’s total import expenditure went towards petroleum products, which was equal to 30-50% of total export revenues, according to the MPRD. Until recently the CPC sold petroleum products at a loss, due to extant subsidies and a large federal tax on fuel imports, resulting in the state-owned firm amassing considerable debt. However, 2015 import costs were lower than 2014 due to declining international prices. This was considered a huge relief on Sri Lanka’s balance of payments, and allowed the government to reduce local fuel prices, which has been welcomed by manufacturers. As many as 5.5m families have benefitted from state-led fuel price reductions, equivalent to $600m in savings. Sri Lanka also reduced tariffs by 25% in 2014 due to an influx of coal power. Furthermore, despite international oil prices declining rapidly since mid-2014, structural inefficiencies have meant that as of March 2016 the CPC had not reduced its domestic prices, with the exception of a one-off government mandated fuel price cut in January 2015. Indeed, in the first 11 months of 2015 the CPC recorded losses of LKR13.2bn ($95m). A new fuel pricing formula, designed by the MPRD in conjunction with the CPC and other stakeholders, was presented to Sri Lanka’s government in early 2016. Aiming to better reflect the economic reality of international oil prices, the new formula is expected to be put in place before the end of the year, though negotiations are ongoing.

In the long term, the government hopes to reduce Sri Lanka’s reliance on foreign fuel by building up the domestic petroleum industry. The discovery in the late-2000s of oil and gas in two wells in the offshore Mannar Basin – located off the western coast of the island – bode well in this regard. Cairn Lanka, a wholly owned subsidiary of Cairn India and Vedanta Resources, an India-based mining firm, was responsible for the find under an exploration contract signed with Sri Lanka’s government in 2008. In late 2015 Cairn announced that it would abandon its efforts in Mannar and exit Sri Lanka, as the low price of oil had made expensive offshore drilling operations financially untenable. Since then the MPRD, with Cairn’s valuable seismic studies in hand, has set out to launch a new tender for offshore exploration in the Mannar Basin, with an eye towards attracting a major international player to continue work (see analysis).

Sri Lanka has two oil marketers in total, the state-owned CPC and Indian Oil Company’s Sri Lanka affiliate, Lanka IOC, which entered the sector in 2002. Lanka IOC operates 189 fuel stations island-wide and carries an estimated 18% of the downstream market. Apart from retail, Lanka IOC has expressed interest in expanding its business in refining, liquefied petroleum gas, bitumen, lubricants and bunkering from its Trincomalee oil terminal. The company’s 2004 initial public offering on the Colombo Stock Exchange was one of the largest on record, raising LKR3.2bn ($23m).

Outlook

Private players involved in Sri Lanka’s energy and utilities industries currently face a number of challenges. Government-owned former monopoly firms – such as the CEB and CPC – continue to hold dominant positions across the sector, and there appears to be little appetite for privatisation in the near future. More fundamentally, in recent decades the country’s power sector has become increasingly reliant on expensive imported petroleum products, which are a drain on the nation’s trade accounts. However, the introduction of coal has reduced this dependence greatly, and although a reliance on coal is unsustainable over time, lower prices for both petrol and coal have alleviated many previous balance of payments issues. Under the new government, the state is working to bring the energy and utilities sectors into alignment in terms of policy developments.

Source: Oxford Business Group.

https://www.oxfordbusinessgroup.com/overview/power-surge-new-government-has-set-out-rejuvenate-nation%E2%80%99s-energy-and-utilities-industries