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Electricity as a traded good
Energy Policy 62 (2013) 1048–1052
Contents lists available at ScienceDirect
Energy Policy journal homepage: www.elsevier.com/locate/enpol
Communication
Electricity as a traded good Sunderasan Srinivasan n Verdurous Solutions Private Limited, Mysore, India
H I G H L I G H T S
Electricity as principal export of small economy. Bilateral trade with large economy. Tourism as major income generator for small economy. Partial equilibrium model involving key variables. Small economy would need to diversify. Important subject for inter-temporal and inter-regional trade of power.
art ic l e i nf o
a b s t r a c t
Article history: Received 4 January 2013 Accepted 1 August 2013 Available online 20 August 2013
Electric power has traditionally been classified as a non-traded good, produced and consumed within the country of origin. More recently, electricity has been traded across national borders and in certain cases, viz., Bhutan, has been the dominant export; in other situations, it is used to repay debts owed to neighboring countries. This paper investigates the role of electricity as the primary export, analyzes its valuation, and then goes on to evaluate the impact on the terms of trade. We conclude that in the medium-term, the electric power exporting economy would be better off developing its manufacturing sector to diversify its exposure and to protect its trade interests. The case of Bhutanese hydro-electricity exports to India is studied and the change in trade advantage with every increase in power tariff is ascertained. It is found that a 1.26% annual increase in (non-food) consumer prices is correlated with a 1% increase in electricity export tariff. While the causality from electric power tariff to Indian manufactures prices is not established statistically, a change in manufactures prices feeding back into consumer prices in Bhutan is statistically significant. Suggestions are offered for Bhutan to reduce dependence on Indian imports and to diversify its export market exposure. & 2013 Elsevier Ltd. All rights reserved.
Keywords: Electricity export Terms-of-trade Real exchange rates Comparative advantage
1. Introduction Traditionally, finished produce or totally unrelated goods, viz., wine and cheese, have been employed to illustrate trade theory and when included, electric power has been analyzed as a nontraded good, consumed at or around the point of generation. More recently, with rapid increases in power consumption and owing to geo-political uncertainties associated with fossil-fuel and coal supplies, long distance transmission and cross-border trade in electricity have been on the rise. Electric power is also increasingly being utilized as a currency to barter for other finished produce: in April 2010, the ‘Energy for Debt’ plan, treating kilowatts of electric
n
Tel./fax: +91 821 2547 553. E-mail address: [email protected] URL: http://www.verdurous.in
0301-4215/$ - see front matter & 2013 Elsevier Ltd. All rights reserved. http://dx.doi.org/10.1016/j.enpol.2013.08.004
power as currency was proffered to help Iceland repay nearly USD 5 billion in debts owed to the United Kingdom and to The Netherlands (Businessworld, 2010). Proposals for supply of electric power generated from solar PV or other renewable sources, from debt-ridden Greece and from North-African countries like Morocco, to European Union member states, have been discussed for a few years now. Likewise, electricity, generated from hydro-electric projects located in Bhutan and exported to India, contributes a sizable portion of the Himalayan Kingdom′s government revenues, (Aiyar, 2009). This paper develops a model for trade in electricity and the consequent impact on the terms-of-trade of the exporter nation. Suggestions are put forth to help the power-exporter sustain a trade advantage. This article models a two-nation universe comprising ‘S’ (small), an electric power exporter and L (large), an electricity importer and exporter of manufactures. Owing to the availability of a low marginal cost energy resource in S, viz., a favorable
S. Srinivasan / Energy Policy 62 (2013) 1048–1052
hydro-electric, geo-thermal or a wind-energy resource site, an integrated energy system with generation located in S yields economies of scale and improved environmental outcomes compared to multiple power plants installed in L, (Watcharejyothin and Shresthaa, 2009). Consequent to the cross-border transmission of electric power, country L benefits from the increased and reliable availability of power and lower energy costs (Parisio and Bosco, 2008), while country S earns export revenues from the sale of power harnessed from a resource that would otherwise remain underutilized. Additionally, cross-border electricity trade enhances overall system efficiency if differences in peak-load times exist among countries lying in different time zones, or if consumption is driven by seasonal differences among countries straddling different latitudes, (Shakouri et al., 2009).
2. Terms of trade Standard notation for exchange rate behavior is employed here: s is the (spot) nominal exchange rate quoted in units of domestic currency per unit of foreign currency (direct quotation); p denotes the aggregate price index and the ‘asterix’ mark superscripts denote corresponding variables for the foreign country. Electricity represents the traded good exported1 and inbound tourism into S, the non-traded good. It is assumed that manufactures are largely imported from the trading partner, L.
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2.2. Evolution in terms of trade 2.2.1. First order condition In a quest to enlarge the consumption basket, U, if economy S raises electricity tariff by Δm, the total revenues from the sale of power grow to Re ¼ M (m+Δm). 2.2.2. Imports However, since electricity is an input into the production process whose finished produce is exported to economy S, prices in L rise to (pn+Δpn) such that U changes to k M (m+Δm)/ (pn+Δpn). The change in aggregate welfare of S depends on the relative magnitude of Δm and Δpn: ceteris paribus an increase in electricity tariff is most likely to be welfare reducing for the exporting nation if Δpn is larger than Δm. 2.2.3. Inbound tourism Residents of S pay higher prices for the imported produce. Likewise, nationals of L (or without loss of generality all visitors) touring S, are required to pay higher prices of the order of s. Δpn, when they consume the tourism services on offer. Assuming no quotas or other restrictions on tourist flows, if ‘l’ is the price elasticity of demand for tourism services, this leads to a change in tourism revenues by l s Δpn. Overall impact in tourism revenues depends on the magnitude and sign of ‘l’. 2.3. Aggregate welfare for economy S Total revenues for S ¼ revenue from sale of electricity ðRe Þ þrevenue from sale of tourism services ðRt Þ ð1Þ
2.1. Characteristics of trade in electricity
M is the quantity of electrical energy (MW h) metered at S and
exported each year from S to L, at a unit price m, yielding a total revenue of Re ¼ M m (or M m(1/s) measured in the foreign currency). Since electricity suffers transmission losses (technical loses), a fraction of the power is lost in transit. The actual power reaching L, therefore is k M, such that k o1.0. From the perspective of economy L, the unit price of electricity paid is therefore mnn ( 4m)¼Re/k. Progressive increase in the quantity of power exported and in the unit-tariff received yields greater revenues and hence creates ever greater demand for the home currency and leads to its consequent appreciation. This primary export boom and the resulting strengthening of the currency could lead to deindustrialization in S, as predicted by Dutch disease models, (Kamas, 1986). However, considering that electricity is an intermediate input, this situation is reversed with the subsequent import of finished produce from L. Revenue from the sale of electric power is used to import finished goods from L at an aggregate price level of pn yielding a consumption basket U¼M m/s pn (ignoring consumption of local resources viz, transportation, distribution, marketing, shelf-space etc. in S). Providing for the actual amount of electric power reaching L, the prices of finished produce rise from pn to pn/k (k o1.0) and the consumption basket shrinks to U¼k M m/s pn.
wherein change in the first term on the RHS is presumed to be positive, given relatively inelastic demand for electricity (Amusa et al., 2009; Bhargava et al., 2009) and the sign of the second term would depend on the elasticity of tourism demand among other factors (Crouch, 1996; Divisekera, 2003). However, the change in aggregate welfare of economy S would depend on the consumption bundle U which is paid for from the above revenues: ΔU=Δm ¼ k M½ðm þ ΔmÞ=ðpn þ Δpn Þm=pn þ½ðRt Þ fℓ=ðpn þ Δpn Þ–1=pn g=s
ð2Þ
The change in aggregate welfare (“utility”) therefore depends on the price response in the large economy (manufactures) and the elasticity in demand for tourism services (the non-traded good) representing the non-traded component. In the situation where the capacity for power generation is pre-determined and cannot be expanded in the short-run, and where an increase in tariff is welfare reducing, S merely converts an absolute advantage into a comparative disadvantage by importing higher finished goods prices from L. We ignore the impact of tourism revenues on aggregate revenues and utility, since per-capita spends by visiting tourists and the numbers of tourists visiting a country depend on several qualitative factors that are beyond the purview of this analysis (Crouch, 1996).
3. The budget constraint In equilibrium, the value of consumption must be equal to the value of production i.e., considering electricity and manufactures:
1
Ignoring domestic consumption, which could be negligible relative to the quantity exported and hence obviating the threat of an increase in domestic tariffs consequent to cross-border trade (see for instance Finon and Romano, 2009).
P M DM þ P E DE ¼ P M Q M þ P E Q E
ð3Þ
where ‘D’ is the demand and ‘Q’ is the quantity produced of manufactures and electricity, respectively.
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S. Srinivasan / Energy Policy 62 (2013) 1048–1052
Quantity of Manufactures
τ
Country S’s budget constraint
Country S’s manufactures imports Quantity of Electricity Country S’s electricity exports
Fig. 1. Decline in utility consequent to an increase in the price of exported intermediate good (electricity).
On rearranging the above equation: DM –Q M ¼ ðP E =P M Þ ðQ E –DE Þ
ð4Þ
Exporting an extra unit of electric power at PE brings in additional earning which helps economy S import PE/PM extra units of manufactures from L (Eq. (4)). The right hand side of the above budget-constraint equation quantifies S’s export of electricity and demonstrates that the import of manufactures is constrained by the amount of electricity exports. However, the generation capacity is predetermined and is further limited by the availability of the resource in question, viz., hydrology in the case of hydro-electricity, wind etc.; major increases in power output can be achieved over many years and from making substantial investments. Further, since electricity is an input into the manufacturing process, an increase in PE feeds into the pricing of manufactures i.e., PM: the evolution of PM is not totally independent of PE. The budget constraint with a slope of PE/PM represents the economy′s choice of production of electricity relative to manufactures. If S enjoys a trade surplus, its currency would appreciate making electric power more expensive (from m/s′ to m/s″ such that s″ os′) in L. Such cost escalation would in turn serve to eliminate the trade surplus owing to the higher outflows from imports. Alternatively, with every adverse movement in the terms of trade i.e., with PM rising relative to PE (for instance when PE is held constant under long-term power purchase agreements while PM rises owing to increase in prices of other inputs to the manufacturing process), economy S loses a part of its ‘currency’ and can exchange the same quantity of electricity for a lower quantity of manufactures (lower by ‘τ’) in Fig. 1. In this context, a competitive devaluation of the currency to encourage power exports would have no impact owing to generation capacity constraints. For economy S to ensure that the utility from its consumption basket remains constant, S would progressively need to build up indigenous capacity in manufacturing, diversifying its exposure, creating jobs in the process and enhancing its own terms of trade. With each increase of Δpn in pn, the local content in the consumption basket would have to be raised by ‘τ’. Economy S could also consider ‘capturing’ and ‘embedding’ the surplus energy into other devices viz., solar photovoltaic wafer, cells or even modules or wind turbines and the like, for sale to other not necessarily geographically contiguous markets.
4. Case study: Bhutan′s bilateral trade with India India is Bhutan′s principal trading partner and hydro-electric power is Bhutan′s principal export. Three hydro electric projects namely Chukha (336 MW), Karichu (60 MW) and Tala (1020 MW) have been built with Indian assistance and are currently
operational while Punatsangchu stage-1 (1200 MW) is under construction. Expansion of generation capacity in Bhutan through green-field projects is an important component of India′s long-run electric power strategy (Businessline, 2009). In the year 2008, Bhutan′s aggregate exports were valued at USD 519 million, of which USD 494 million or about 95% of the Kingdom′s exports were to India. Among others, exports to India comprised electric power worth USD 228 million (51.4% of total exports to India) base metals worth 108.8 million (24.4%) and USD 44.8 million (10.1%) of mineral products, (IMF, 2009). Similarly, Bhutan imported a total of USD 540 million worth of which USD 399 million or about 74% were from India. About USD 102.2 million (28.5% of all imports from India) worth of mineral products (and electricity to villages closer to the Indian border), about USD 61 million (17%) worth of base metal products and base metals and about USD 42.8 million (11.9%) worth of machinery and mechanical appliances were imported. By the year 2011, India′s exports to Bhutan had increased to USD 660 million (72% of Bhutan′s total imports) and India′s imports from Bhutan were valued at USD 495 million (converted at INR 53.3/USD), (84% of Bhutan′s total exports), (MEA, 2013). It is reported that between April 2012 and January 2013, the total power generation in India was 762,668 million kW h including 4710 million kW h (against a target of 5480 million kW h) of hydro-electric power imported from Bhutan, representing about 0.62% of India′s indigenous power generation (The Hindu, 2013). Observers have estimated that Bhutan′s power exports could meet 1% of India′s total power needs, (Sharma, 2012). In July 2013, electricity was moved from being a ‘restricted’ import good to a ‘free’ import good vide an amendment to the Indian import policy on electrical energy. The construction of hydro-electric power generation plants and the export of electricity continue to play a significant part in the growth of Bhutan′s GDP and have created large-scale, long-term, high-quality employment opportunities (IFC, 2012). Even as the power imported from Bhutan is relatively of small order in absolute terms, it plays an important role in bridging the demand—supply gap, especially within the difficultto-access Eastern and North-Eastern states of India, (Singh, 2013). Hence, the following statistical analysis is undertaken from a strategic perspective; [stage-1] of the flow-chart depicted herein below. The deeply politicized electricity sector in India has been operating a non-linear pricing scheme that is not necessarily consistent with cost recovery, and one where industrial and commercial consumers cross-subsidize the agriculture sector which pays negligible tariffs for the power consumed. This, when combined with high levels of technical and commercial losses (thefts), has rendered most of the state-level electricity utilities bankrupt. The difference between the average procurement cost and the average revenue realized per kW h is of the order about US 1 cent per kW h (Dutta, 2011). The losses of the distribution companies in just seven states, (before subsidies), Tamil Nadu, Uttar Pradesh, Madhya Pradesh, Jammu & Kashmir and Haryana, Andhra Pradesh and the Punjab were estimated to have been in excess of USD 16 billion as of March 2012, (Tyagi, 2012). Consequently, hardware and infrastructure have not been upgraded in tandem with increasing demand and hence power supplied is often unreliable and of poor quality. The industrial sector has resorted to installing higher marginal cost captive generation capacity, viz., diesel generators, to meet its requirement for high quality reliable power supply, (Joseph, 2010). The higher landed cost of power feeds into higher prices of manufactures, as hypothesized in stages 2 and 3 of the Flowchart 1. The higher import price of electric power, therefore, and fewer industrial consumers to cross-subsidize the agriculture sector, combine to aggravate the financial ill-health of the distribution utilities and
S. Srinivasan / Energy Policy 62 (2013) 1048–1052
Stage - 1
Stage - 2
Stage - 3
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Stage - 4
Stage - 5
Increase in Power
Higher “whole -
Worsens financial
Higher landed cost
Higher priced
Tariff by Bhutan
sale” cost of power
health of utilities;
of power feeds into
manufactures
in India
industry sets - up
price of
exported to
capti ve generation;
manufactures
Bhutan.
Flowchart 1. Import of higher-priced electricity and the export of higher-priced merchandise. Consumption Basket
Table 1 Pricing and Inflation data for Bhutan and India. Year
τ=1.26% decline in
utility for each 1% increase in export power tariff Bhutan’s metals / minerals imports
Bhutan’s budget constraint
Quantity of Electricity Bhutan’s electricity exports
Fig. 2. Decline in utility for Bhutan consequent to a 1% increase in the price of exported (electricity).
2003 2004 2005 2006 2007 2008 CAGR
Bhutan
India
Bhutan
Electricity Tariffa
Metal productsb
Mineral productsb
Non-food Inflationc
1.6692 1.4707 2.1195 2.5641 2.7543 2.0322 4.014%
160.100 195.500 218.800 225.000 244.600 285.500 12.265%
146.700 154.800 167.100 186.400 204.800 215.500 7.995%
102.300 106.900 112.100 118.100 121.600 131.000 5.070%
a
initiate a vicious cycle of worsening infrastructure and poorer quality of power delivery and of larger numbers of commercial and industrial consumers opting out of the system, leading to stage 4 of the flow-chart. So long as they remain competitive, these higher priced goods are distributed within domestic as well as international markets and they find their way into Bhutan as well, alongside other export markets (stage 5). Salah Uddin et al. (2010) have established the unidirectional causality from growth in export – primarily electricity – to GDP growth and to rising imports for Bhutan, while also confirming that Bhutan mostly imports consumer durables and not capital goods. We hypothesize that an increase in electricity export tariff (Δm) in Bhutan feeds into higher prices (pn+Δpn) for products in India, which are then exported to Bhutan, traversing an upward spiral in consumer prices. The reduction in competitive advantage (τ) as shown in Fig. 2, owing to an increase in tariffs can thus be estimated. Table 1 provides the data for the annual average export tariff for supply of electric power from Bhutan to India.2 The indexed prices for metal and mineral products are drawn from relevant Indian government publications.3 The consumer inflation data for Bhutan is extracted from the Statistical Appendix to the IMF country report. Table 1 demonstrates that an annual increase in power tariff of 4.014% correlates with a 5.070% increase in nonfood prices in Bhutan, corresponding to non-food inflation of 1.26% per 1.00% increase in electricity tariff. We run ordinary least squares (OLS) regressions of the following form: Metal=mineral products pricing in India ¼ α1 þ β1 ðelectricity import tariff Þ þ m Consumer prices in Bhutan ¼ α2 þ β2 ðMetal=mineralproductspricinginIndiaÞ þ m:
ð5Þ
Table 2 displays the OLS results. It is not established that price increases in metals and non-metallic mineral products are on account of power tariff escalation, possibly because the quantity of power imported from Bhutan is small, relative to the total power 2 Author;s computations based on quantity of power exported and the revenues reported. 3 eaindustry.nic.in.
Average annual export tariff in Ngultrum. Price index data from eaindustry.nic.in (1993–1994 ¼100). c Non-food inflation data from Table 8, Statistical Appendix to Country Report No. 09/335 (Q3 2003 ¼100). b
consumed in India, and possibly owing to evolution in pricing of other inputs. However, it is possible for us to conclude that higher consumer prices in Bhutan are owing to higher prices of imported goods viz., metal and non-metallic mineral products, which constitute a significant proportion of Bhutan′s imports from India. Evidently, this is an economic variant of the ‘resource curse’.4 Testing for Granger causality of inflation in Bhutan being fuelled by (all commodity) inflation in India reveals consistent patterns of export of inflation within one and three quarters and leads to a divergence between the nominal and real valuation of the Bhutanese Ngultrum.
5. Conclusions If all the planned projects for harnessing hydro power materialize and revenues from electricity exports far exceed the expenditure on imports, Bhutan would enjoy a large balance-ofpayments surplus and could be in danger of contracting the Dutch disease, discouraging the development of the manufacturing sector, (Kojo, 2005). The Bhutanese policy makers would have to choose between two seemingly adverse options: allowing the Bhutanese Ngultrum to appreciate or to suffer high inflation on account of an artificially weak currency,5 since India and Bhutan obviously do not constitute an optimal currency area. However, current levels of consumption could be sustained if and only if marginal increases in generation capacity are progressively achieved, to compensate for the loss in trade advantage. Alternatively, Bhutan could develop indigenous industry to produce manufactures that the country would otherwise import or could diversify its exposure to the energy industry by initiating the manufacture of silicon wafer for the solar photovoltaic industry, 4 The ‘resource curse’ hypothesis suggests that natural resource endowments tend to strengthen, empower and enrich the ruling elite at the expense of the common people. 5 This analysis ignores budgetary support and overseas development assistance from India or other countries.
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S. Srinivasan / Energy Policy 62 (2013) 1048–1052
Table 2 OLS results for inflation transmission.
Metal product pricing (India) Mineral product pricing (India) Consumer price (Bhutan) Consumer price (Bhutan) Consumer price (Bhutan) Consumer price (Bhutan)
a
Electricity import tariff
127.3353 (1.6145) 99.3368 (2.2658) 62.0915 (12.1670) 48.8802 (7.8291) 53.8905 (12.8824) 53.076403 (10.5055)
44.8440 (1.2224) 38.0075 (1.8638)
Metal product pricing (India)
Mineral product pricing (India)
0.2403a (10.5927)
1.147852013 (0.5225)
0.1220b (2.8089) 0.104733757 (1.7479)
0.3708a (10.7488) 0.1919b (2.8639) 0.231351804 (2.1463)
t Statistic provided in parenthesis. a b
Significant at 99%. Significant at 90%.
wind turbines etc., so as to ‘capture’, ‘embed’ and ‘export’ the energy to other, more distant markets. References Aiyar, Swaminathan S.Anklesaria, 2009. Bhutan′s happiness is large dam, fast GDP. The Times of India. Amusa, Hammed, Amusa, Kafayat, Mabugua, Ramos, 2009. Aggregate demand for electricity in South Africa: an analysis using the bounds testing approach to cointegration. Energy Policy 37 (10), 4167–4175. Bhargava, Nisha, Singh, Baldev, Gupta, Shakuntla, 2009. Consumption of electricity in Punjab: structure and growth. Energy Policy 37 (6), 2385–2394. Businessline 2009. Pact with Bhutan for 4 Hydel Projects, 23 December 2009. Businessworld 2010. Energy: Electric Currency, 19th April 2010, p. 17. Crouch, Geoffrey I., 1996. Demand elasticities in international marketing: a metaanalytical application to tourism. Journal of Business Research 36 (2), 117–136. Divisekera, Sarath, 2003. A model of demand for international tourism. Annals of Tourism Research 30 (1), 31–49. Dutta, Sanjay, 2011. Now, Power Tariffs Likely to Go Up. The Times of India, Mysore ed. p. 11. Finon, Dominique, Romano, Elliot, 2009. Electricity market integration: redistribution effect versus resource reallocation. Energy Policy 37 (8), 2977–2985. IFC 2012. Estimating Employment Effects of Powerlinks Transmission Limited Project in India and Bhutan, International Finance Corporation (IFC), Development Impact Department, 〈http://www.ifc.org/wps/wcm/connect/ 04c72a804d6129bf8743e72389a1bab4/Powerlinks_full_report.pdf?MOD=AJ PERES〉, last accessed 29 July 2013. IMF 2009. Bhutan: Statistical Appendix to Country Report No. 09/335, December.
Joseph, Kelli L., 2010. The politics of power: electricity reform in India. Energy Policy 38, 503–511. Kamas, Linda, 1986. Dutch disease economics and the Colombian export boom. World Development 14 (9), 1177–1198. Kojo Naoko C 2005. Bhutan: Power Exports and Dutch Disease 〈http://archiv.ub. uni-heidelberg.de/savifadok/volltexte/2009/306〉, last accessed 29 July 2013. MEA 2013. India–Bhutan Relations, Ministry of External Affairs, Government of India, 〈http://www.mea.gov.in/Portal/ForeignRelation/India-Bhutan_Relations. pdf〉 p. 3, June 2013, last accessed 29 July 2013. Parisio, Lucia, Bosco, Bruno, 2008. Electricity prices and cross-border trade: volume and strategy effects. Energy Economics 30 (4), 1760–1775. Salah Uddin, Gazi Mohammed, Khan, Shibli A, Alam, Mahmudul Mohammed, 2010. An empirical study on export, import and GDP growth in Bhutan. Indian Development Review 8 (1), 95–104. Shakouri, H., Eghlimi, M., Manzoor, D., 2009. Economically optimized electricity trade modeling: Iran–Turkey case. Energy Policy 37 (2), 472–483. Sharma, Rakesh, 2012. India′s power demand fuels Bhutan′s economy. The Wall Street Journal. (30 July 2012, last accessed 29 July 2013). Singh, Sudheer Pal, 2013. India, Bhutan power plant collaborations in Limbo. Business-Standard 8. (last accessed 29 July 2013). The Hindu 2013. Import of Power Made Easy, The Hindu, Chennai ed., 5 July 2013, 〈http://www.thehindu.com/business/Industry/import-of-power-made-easy/ article4885312.ece〉, last accessed 29 July 2013. Tyagi, Chhavi, 2012. Red Discoms Woo black: loss-making power distribution companies get a new lifeline. Businessworld, 14. Watcharejyothin, Mayurachat, Shresthaa, Ram M., 2009. Effects of cross-border power trade between Laos and Thailand: energy security and environmental implications. Energy Policy 37 (5), 1782–1792.
Contents lists available at ScienceDirect
Energy Policy journal homepage: www.elsevier.com/locate/enpol
Communication
Electricity as a traded good Sunderasan Srinivasan n Verdurous Solutions Private Limited, Mysore, India
H I G H L I G H T S
Electricity as principal export of small economy. Bilateral trade with large economy. Tourism as major income generator for small economy. Partial equilibrium model involving key variables. Small economy would need to diversify. Important subject for inter-temporal and inter-regional trade of power.
art ic l e i nf o
a b s t r a c t
Article history: Received 4 January 2013 Accepted 1 August 2013 Available online 20 August 2013
Electric power has traditionally been classified as a non-traded good, produced and consumed within the country of origin. More recently, electricity has been traded across national borders and in certain cases, viz., Bhutan, has been the dominant export; in other situations, it is used to repay debts owed to neighboring countries. This paper investigates the role of electricity as the primary export, analyzes its valuation, and then goes on to evaluate the impact on the terms of trade. We conclude that in the medium-term, the electric power exporting economy would be better off developing its manufacturing sector to diversify its exposure and to protect its trade interests. The case of Bhutanese hydro-electricity exports to India is studied and the change in trade advantage with every increase in power tariff is ascertained. It is found that a 1.26% annual increase in (non-food) consumer prices is correlated with a 1% increase in electricity export tariff. While the causality from electric power tariff to Indian manufactures prices is not established statistically, a change in manufactures prices feeding back into consumer prices in Bhutan is statistically significant. Suggestions are offered for Bhutan to reduce dependence on Indian imports and to diversify its export market exposure. & 2013 Elsevier Ltd. All rights reserved.
Keywords: Electricity export Terms-of-trade Real exchange rates Comparative advantage
1. Introduction Traditionally, finished produce or totally unrelated goods, viz., wine and cheese, have been employed to illustrate trade theory and when included, electric power has been analyzed as a nontraded good, consumed at or around the point of generation. More recently, with rapid increases in power consumption and owing to geo-political uncertainties associated with fossil-fuel and coal supplies, long distance transmission and cross-border trade in electricity have been on the rise. Electric power is also increasingly being utilized as a currency to barter for other finished produce: in April 2010, the ‘Energy for Debt’ plan, treating kilowatts of electric
n
Tel./fax: +91 821 2547 553. E-mail address: [email protected] URL: http://www.verdurous.in
0301-4215/$ - see front matter & 2013 Elsevier Ltd. All rights reserved. http://dx.doi.org/10.1016/j.enpol.2013.08.004
power as currency was proffered to help Iceland repay nearly USD 5 billion in debts owed to the United Kingdom and to The Netherlands (Businessworld, 2010). Proposals for supply of electric power generated from solar PV or other renewable sources, from debt-ridden Greece and from North-African countries like Morocco, to European Union member states, have been discussed for a few years now. Likewise, electricity, generated from hydro-electric projects located in Bhutan and exported to India, contributes a sizable portion of the Himalayan Kingdom′s government revenues, (Aiyar, 2009). This paper develops a model for trade in electricity and the consequent impact on the terms-of-trade of the exporter nation. Suggestions are put forth to help the power-exporter sustain a trade advantage. This article models a two-nation universe comprising ‘S’ (small), an electric power exporter and L (large), an electricity importer and exporter of manufactures. Owing to the availability of a low marginal cost energy resource in S, viz., a favorable
S. Srinivasan / Energy Policy 62 (2013) 1048–1052
hydro-electric, geo-thermal or a wind-energy resource site, an integrated energy system with generation located in S yields economies of scale and improved environmental outcomes compared to multiple power plants installed in L, (Watcharejyothin and Shresthaa, 2009). Consequent to the cross-border transmission of electric power, country L benefits from the increased and reliable availability of power and lower energy costs (Parisio and Bosco, 2008), while country S earns export revenues from the sale of power harnessed from a resource that would otherwise remain underutilized. Additionally, cross-border electricity trade enhances overall system efficiency if differences in peak-load times exist among countries lying in different time zones, or if consumption is driven by seasonal differences among countries straddling different latitudes, (Shakouri et al., 2009).
2. Terms of trade Standard notation for exchange rate behavior is employed here: s is the (spot) nominal exchange rate quoted in units of domestic currency per unit of foreign currency (direct quotation); p denotes the aggregate price index and the ‘asterix’ mark superscripts denote corresponding variables for the foreign country. Electricity represents the traded good exported1 and inbound tourism into S, the non-traded good. It is assumed that manufactures are largely imported from the trading partner, L.
1049
2.2. Evolution in terms of trade 2.2.1. First order condition In a quest to enlarge the consumption basket, U, if economy S raises electricity tariff by Δm, the total revenues from the sale of power grow to Re ¼ M (m+Δm). 2.2.2. Imports However, since electricity is an input into the production process whose finished produce is exported to economy S, prices in L rise to (pn+Δpn) such that U changes to k M (m+Δm)/ (pn+Δpn). The change in aggregate welfare of S depends on the relative magnitude of Δm and Δpn: ceteris paribus an increase in electricity tariff is most likely to be welfare reducing for the exporting nation if Δpn is larger than Δm. 2.2.3. Inbound tourism Residents of S pay higher prices for the imported produce. Likewise, nationals of L (or without loss of generality all visitors) touring S, are required to pay higher prices of the order of s. Δpn, when they consume the tourism services on offer. Assuming no quotas or other restrictions on tourist flows, if ‘l’ is the price elasticity of demand for tourism services, this leads to a change in tourism revenues by l s Δpn. Overall impact in tourism revenues depends on the magnitude and sign of ‘l’. 2.3. Aggregate welfare for economy S Total revenues for S ¼ revenue from sale of electricity ðRe Þ þrevenue from sale of tourism services ðRt Þ ð1Þ
2.1. Characteristics of trade in electricity
M is the quantity of electrical energy (MW h) metered at S and
exported each year from S to L, at a unit price m, yielding a total revenue of Re ¼ M m (or M m(1/s) measured in the foreign currency). Since electricity suffers transmission losses (technical loses), a fraction of the power is lost in transit. The actual power reaching L, therefore is k M, such that k o1.0. From the perspective of economy L, the unit price of electricity paid is therefore mnn ( 4m)¼Re/k. Progressive increase in the quantity of power exported and in the unit-tariff received yields greater revenues and hence creates ever greater demand for the home currency and leads to its consequent appreciation. This primary export boom and the resulting strengthening of the currency could lead to deindustrialization in S, as predicted by Dutch disease models, (Kamas, 1986). However, considering that electricity is an intermediate input, this situation is reversed with the subsequent import of finished produce from L. Revenue from the sale of electric power is used to import finished goods from L at an aggregate price level of pn yielding a consumption basket U¼M m/s pn (ignoring consumption of local resources viz, transportation, distribution, marketing, shelf-space etc. in S). Providing for the actual amount of electric power reaching L, the prices of finished produce rise from pn to pn/k (k o1.0) and the consumption basket shrinks to U¼k M m/s pn.
wherein change in the first term on the RHS is presumed to be positive, given relatively inelastic demand for electricity (Amusa et al., 2009; Bhargava et al., 2009) and the sign of the second term would depend on the elasticity of tourism demand among other factors (Crouch, 1996; Divisekera, 2003). However, the change in aggregate welfare of economy S would depend on the consumption bundle U which is paid for from the above revenues: ΔU=Δm ¼ k M½ðm þ ΔmÞ=ðpn þ Δpn Þm=pn þ½ðRt Þ fℓ=ðpn þ Δpn Þ–1=pn g=s
ð2Þ
The change in aggregate welfare (“utility”) therefore depends on the price response in the large economy (manufactures) and the elasticity in demand for tourism services (the non-traded good) representing the non-traded component. In the situation where the capacity for power generation is pre-determined and cannot be expanded in the short-run, and where an increase in tariff is welfare reducing, S merely converts an absolute advantage into a comparative disadvantage by importing higher finished goods prices from L. We ignore the impact of tourism revenues on aggregate revenues and utility, since per-capita spends by visiting tourists and the numbers of tourists visiting a country depend on several qualitative factors that are beyond the purview of this analysis (Crouch, 1996).
3. The budget constraint In equilibrium, the value of consumption must be equal to the value of production i.e., considering electricity and manufactures:
1
Ignoring domestic consumption, which could be negligible relative to the quantity exported and hence obviating the threat of an increase in domestic tariffs consequent to cross-border trade (see for instance Finon and Romano, 2009).
P M DM þ P E DE ¼ P M Q M þ P E Q E
ð3Þ
where ‘D’ is the demand and ‘Q’ is the quantity produced of manufactures and electricity, respectively.
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Quantity of Manufactures
τ
Country S’s budget constraint
Country S’s manufactures imports Quantity of Electricity Country S’s electricity exports
Fig. 1. Decline in utility consequent to an increase in the price of exported intermediate good (electricity).
On rearranging the above equation: DM –Q M ¼ ðP E =P M Þ ðQ E –DE Þ
ð4Þ
Exporting an extra unit of electric power at PE brings in additional earning which helps economy S import PE/PM extra units of manufactures from L (Eq. (4)). The right hand side of the above budget-constraint equation quantifies S’s export of electricity and demonstrates that the import of manufactures is constrained by the amount of electricity exports. However, the generation capacity is predetermined and is further limited by the availability of the resource in question, viz., hydrology in the case of hydro-electricity, wind etc.; major increases in power output can be achieved over many years and from making substantial investments. Further, since electricity is an input into the manufacturing process, an increase in PE feeds into the pricing of manufactures i.e., PM: the evolution of PM is not totally independent of PE. The budget constraint with a slope of PE/PM represents the economy′s choice of production of electricity relative to manufactures. If S enjoys a trade surplus, its currency would appreciate making electric power more expensive (from m/s′ to m/s″ such that s″ os′) in L. Such cost escalation would in turn serve to eliminate the trade surplus owing to the higher outflows from imports. Alternatively, with every adverse movement in the terms of trade i.e., with PM rising relative to PE (for instance when PE is held constant under long-term power purchase agreements while PM rises owing to increase in prices of other inputs to the manufacturing process), economy S loses a part of its ‘currency’ and can exchange the same quantity of electricity for a lower quantity of manufactures (lower by ‘τ’) in Fig. 1. In this context, a competitive devaluation of the currency to encourage power exports would have no impact owing to generation capacity constraints. For economy S to ensure that the utility from its consumption basket remains constant, S would progressively need to build up indigenous capacity in manufacturing, diversifying its exposure, creating jobs in the process and enhancing its own terms of trade. With each increase of Δpn in pn, the local content in the consumption basket would have to be raised by ‘τ’. Economy S could also consider ‘capturing’ and ‘embedding’ the surplus energy into other devices viz., solar photovoltaic wafer, cells or even modules or wind turbines and the like, for sale to other not necessarily geographically contiguous markets.
4. Case study: Bhutan′s bilateral trade with India India is Bhutan′s principal trading partner and hydro-electric power is Bhutan′s principal export. Three hydro electric projects namely Chukha (336 MW), Karichu (60 MW) and Tala (1020 MW) have been built with Indian assistance and are currently
operational while Punatsangchu stage-1 (1200 MW) is under construction. Expansion of generation capacity in Bhutan through green-field projects is an important component of India′s long-run electric power strategy (Businessline, 2009). In the year 2008, Bhutan′s aggregate exports were valued at USD 519 million, of which USD 494 million or about 95% of the Kingdom′s exports were to India. Among others, exports to India comprised electric power worth USD 228 million (51.4% of total exports to India) base metals worth 108.8 million (24.4%) and USD 44.8 million (10.1%) of mineral products, (IMF, 2009). Similarly, Bhutan imported a total of USD 540 million worth of which USD 399 million or about 74% were from India. About USD 102.2 million (28.5% of all imports from India) worth of mineral products (and electricity to villages closer to the Indian border), about USD 61 million (17%) worth of base metal products and base metals and about USD 42.8 million (11.9%) worth of machinery and mechanical appliances were imported. By the year 2011, India′s exports to Bhutan had increased to USD 660 million (72% of Bhutan′s total imports) and India′s imports from Bhutan were valued at USD 495 million (converted at INR 53.3/USD), (84% of Bhutan′s total exports), (MEA, 2013). It is reported that between April 2012 and January 2013, the total power generation in India was 762,668 million kW h including 4710 million kW h (against a target of 5480 million kW h) of hydro-electric power imported from Bhutan, representing about 0.62% of India′s indigenous power generation (The Hindu, 2013). Observers have estimated that Bhutan′s power exports could meet 1% of India′s total power needs, (Sharma, 2012). In July 2013, electricity was moved from being a ‘restricted’ import good to a ‘free’ import good vide an amendment to the Indian import policy on electrical energy. The construction of hydro-electric power generation plants and the export of electricity continue to play a significant part in the growth of Bhutan′s GDP and have created large-scale, long-term, high-quality employment opportunities (IFC, 2012). Even as the power imported from Bhutan is relatively of small order in absolute terms, it plays an important role in bridging the demand—supply gap, especially within the difficultto-access Eastern and North-Eastern states of India, (Singh, 2013). Hence, the following statistical analysis is undertaken from a strategic perspective; [stage-1] of the flow-chart depicted herein below. The deeply politicized electricity sector in India has been operating a non-linear pricing scheme that is not necessarily consistent with cost recovery, and one where industrial and commercial consumers cross-subsidize the agriculture sector which pays negligible tariffs for the power consumed. This, when combined with high levels of technical and commercial losses (thefts), has rendered most of the state-level electricity utilities bankrupt. The difference between the average procurement cost and the average revenue realized per kW h is of the order about US 1 cent per kW h (Dutta, 2011). The losses of the distribution companies in just seven states, (before subsidies), Tamil Nadu, Uttar Pradesh, Madhya Pradesh, Jammu & Kashmir and Haryana, Andhra Pradesh and the Punjab were estimated to have been in excess of USD 16 billion as of March 2012, (Tyagi, 2012). Consequently, hardware and infrastructure have not been upgraded in tandem with increasing demand and hence power supplied is often unreliable and of poor quality. The industrial sector has resorted to installing higher marginal cost captive generation capacity, viz., diesel generators, to meet its requirement for high quality reliable power supply, (Joseph, 2010). The higher landed cost of power feeds into higher prices of manufactures, as hypothesized in stages 2 and 3 of the Flowchart 1. The higher import price of electric power, therefore, and fewer industrial consumers to cross-subsidize the agriculture sector, combine to aggravate the financial ill-health of the distribution utilities and
S. Srinivasan / Energy Policy 62 (2013) 1048–1052
Stage - 1
Stage - 2
Stage - 3
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Stage - 4
Stage - 5
Increase in Power
Higher “whole -
Worsens financial
Higher landed cost
Higher priced
Tariff by Bhutan
sale” cost of power
health of utilities;
of power feeds into
manufactures
in India
industry sets - up
price of
exported to
capti ve generation;
manufactures
Bhutan.
Flowchart 1. Import of higher-priced electricity and the export of higher-priced merchandise. Consumption Basket
Table 1 Pricing and Inflation data for Bhutan and India. Year
τ=1.26% decline in
utility for each 1% increase in export power tariff Bhutan’s metals / minerals imports
Bhutan’s budget constraint
Quantity of Electricity Bhutan’s electricity exports
Fig. 2. Decline in utility for Bhutan consequent to a 1% increase in the price of exported (electricity).
2003 2004 2005 2006 2007 2008 CAGR
Bhutan
India
Bhutan
Electricity Tariffa
Metal productsb
Mineral productsb
Non-food Inflationc
1.6692 1.4707 2.1195 2.5641 2.7543 2.0322 4.014%
160.100 195.500 218.800 225.000 244.600 285.500 12.265%
146.700 154.800 167.100 186.400 204.800 215.500 7.995%
102.300 106.900 112.100 118.100 121.600 131.000 5.070%
a
initiate a vicious cycle of worsening infrastructure and poorer quality of power delivery and of larger numbers of commercial and industrial consumers opting out of the system, leading to stage 4 of the flow-chart. So long as they remain competitive, these higher priced goods are distributed within domestic as well as international markets and they find their way into Bhutan as well, alongside other export markets (stage 5). Salah Uddin et al. (2010) have established the unidirectional causality from growth in export – primarily electricity – to GDP growth and to rising imports for Bhutan, while also confirming that Bhutan mostly imports consumer durables and not capital goods. We hypothesize that an increase in electricity export tariff (Δm) in Bhutan feeds into higher prices (pn+Δpn) for products in India, which are then exported to Bhutan, traversing an upward spiral in consumer prices. The reduction in competitive advantage (τ) as shown in Fig. 2, owing to an increase in tariffs can thus be estimated. Table 1 provides the data for the annual average export tariff for supply of electric power from Bhutan to India.2 The indexed prices for metal and mineral products are drawn from relevant Indian government publications.3 The consumer inflation data for Bhutan is extracted from the Statistical Appendix to the IMF country report. Table 1 demonstrates that an annual increase in power tariff of 4.014% correlates with a 5.070% increase in nonfood prices in Bhutan, corresponding to non-food inflation of 1.26% per 1.00% increase in electricity tariff. We run ordinary least squares (OLS) regressions of the following form: Metal=mineral products pricing in India ¼ α1 þ β1 ðelectricity import tariff Þ þ m Consumer prices in Bhutan ¼ α2 þ β2 ðMetal=mineralproductspricinginIndiaÞ þ m:
ð5Þ
Table 2 displays the OLS results. It is not established that price increases in metals and non-metallic mineral products are on account of power tariff escalation, possibly because the quantity of power imported from Bhutan is small, relative to the total power 2 Author;s computations based on quantity of power exported and the revenues reported. 3 eaindustry.nic.in.
Average annual export tariff in Ngultrum. Price index data from eaindustry.nic.in (1993–1994 ¼100). c Non-food inflation data from Table 8, Statistical Appendix to Country Report No. 09/335 (Q3 2003 ¼100). b
consumed in India, and possibly owing to evolution in pricing of other inputs. However, it is possible for us to conclude that higher consumer prices in Bhutan are owing to higher prices of imported goods viz., metal and non-metallic mineral products, which constitute a significant proportion of Bhutan′s imports from India. Evidently, this is an economic variant of the ‘resource curse’.4 Testing for Granger causality of inflation in Bhutan being fuelled by (all commodity) inflation in India reveals consistent patterns of export of inflation within one and three quarters and leads to a divergence between the nominal and real valuation of the Bhutanese Ngultrum.
5. Conclusions If all the planned projects for harnessing hydro power materialize and revenues from electricity exports far exceed the expenditure on imports, Bhutan would enjoy a large balance-ofpayments surplus and could be in danger of contracting the Dutch disease, discouraging the development of the manufacturing sector, (Kojo, 2005). The Bhutanese policy makers would have to choose between two seemingly adverse options: allowing the Bhutanese Ngultrum to appreciate or to suffer high inflation on account of an artificially weak currency,5 since India and Bhutan obviously do not constitute an optimal currency area. However, current levels of consumption could be sustained if and only if marginal increases in generation capacity are progressively achieved, to compensate for the loss in trade advantage. Alternatively, Bhutan could develop indigenous industry to produce manufactures that the country would otherwise import or could diversify its exposure to the energy industry by initiating the manufacture of silicon wafer for the solar photovoltaic industry, 4 The ‘resource curse’ hypothesis suggests that natural resource endowments tend to strengthen, empower and enrich the ruling elite at the expense of the common people. 5 This analysis ignores budgetary support and overseas development assistance from India or other countries.
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Table 2 OLS results for inflation transmission.
Metal product pricing (India) Mineral product pricing (India) Consumer price (Bhutan) Consumer price (Bhutan) Consumer price (Bhutan) Consumer price (Bhutan)
a
Electricity import tariff
127.3353 (1.6145) 99.3368 (2.2658) 62.0915 (12.1670) 48.8802 (7.8291) 53.8905 (12.8824) 53.076403 (10.5055)
44.8440 (1.2224) 38.0075 (1.8638)
Metal product pricing (India)
Mineral product pricing (India)
0.2403a (10.5927)
1.147852013 (0.5225)
0.1220b (2.8089) 0.104733757 (1.7479)
0.3708a (10.7488) 0.1919b (2.8639) 0.231351804 (2.1463)
t Statistic provided in parenthesis. a b
Significant at 99%. Significant at 90%.
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