BMI View : The incentives for renewable energy outlined by the 2013 Sri Lankan budget represent a positive development for the country's energy sector. Sri Lanka currently faces possible power shortages and an increasingly unsustainable electricity subsidy, and we believe that renewable energy (specifically wind energy) could help to alleviate these problems. The tax exemption on imported renewable energy equipment could be particularly important, as it would substantially lower the costs of developing renewable assets and dramatically improve returns for investors.
On November 08 2012, Sri Lankan President Mahinda Rajapaksa presented his administration's budget for 2013 to parliament. The budget included several incentives for renewable energy, including an exemption of import taxes for renewable energy equipment which are not manufactured in the country, as well as a reduction of the corporate tax rate on renewable energy producers to 12%.
We believe the incentives outlined by the 2013 budget represent a positive development for the Sri Lankan energy sector. Although the country enjoys the highest access to electricity among its South Asian peers, a high reliance on hydropower and oil-based generation has caused the country to experience two major energy problems.
|Sri Lanka Tops|
|South Asia Electricity Access In 2009, % (LHS) And Population Without Electricity, mn (RHS)|
Power Shortages - Sri Lanka experiences droughts annually, and increases thermal generation to cover the shortfall in hydropower generation during these dry spells. However, in August 2012, a failure in one of the country's coal-fired plants during the dry season led to a severe power shortage. We believe this situation could worsen in the future. Electricity consumption in the country is expected to grow an average of 6.8% per annum over the coming decade, while hydropower resources grow increasingly scarce within the country.
|Highly Reliant On Hydropower|
|Sri Lanka - 2012 Generation Capacity Forecast, MW (LHS) and Generation Forecast, TWh (RHS)|
Unsustainable Electricity Subsidies - Sri Lanka's reliance on costly oil-based generation creates a need for the government to subsidise a substantial portion of the country's overall energy bill to keep electricity affordable. For instance, the power ministry said that it would disburse LKR61bn (US$470mn) of electricity subsidies in 2012, with the bulk (US$287mn) going to households. We believe that these subsidies are increasingly unsustainable. Not only is the country's fiscal deficit at elevated levels (6.2% of GDP in 2012 according to our estimates), but the government also has to purchase oil with lower purchasing power. Since the start of 2012, the average price of crude oil has remained around US$100 per barrel and we expect this to continue over the coming years. On the other hand, the Sri Lankan rupee has weakened significantly over the same period - from LKR 110.5/US$ at the start of 2012 to the current LKR130.1/US$ - and is expected to remain between LKR120-130/US$ over the next decade.
|Oil Price Remains Elevated|
|Brent Crude Prices, US$/bbl (LHS) and Sri Lankan Exchange Rate, LKR/US$ (RHS)|
We believe that renewable energy, especially wind energy, could help alleviate Sri Lanka's energy woes. According to a study by the US National Renewable Energy Laboratory, Sri Lanka has the potential to generate 20,740MW of wind energy. The country enjoys strong winds throughout the year, due to its exposure to the vast Indian Ocean. By developing some of its wind resources, Sri Lanka could reduce its dependence on oil imports and on power generation sources that are reliant on rainfall. The government has also recognised these positive aspects of renewable energy and has implemented an ambitious plan to increase the share of renewable energy in power generation to 10% in 2015 and 20% in 2020.
Prospects For Wind Energy
We believe the new incentives outlined by the budget will be useful in bringing new investment into Sri Lanka. The country already has a feed-in tariff for wind energy, but it has only had limited success in encouraging private interest in the sector. As of August 9 2012, the country had a total installed wind capacity in the country to 63MW (>1% of estimated wind power potential), according to the Ministry of Power and Energy (see ' New Wind Farms Highlight Renewables Demand', August 16 2012).
The new government incentives are expected to encourage new investments into the wind sector by significantly improving returns for investors. The tax exemption on imported renewable energy equipment is particularly important, as most equipment for wind energy have to be imported due to a lack of local manufacturing capabilities. Current import duties stand at 120.6% and the removal of these duties would substantially lower the cost of developing wind assets.
|Duty rate||Value - LKR.|
|Source: Sri Lanka Customs.|
|Sample Good Price||100,000|
|Port And Airport Development Levy||5%||5,000|
|Value Added Tax||12%||24,060|
|Nation Building Tax||3%||6,015|
|Total Tax value||120.575%||120,575|
That said, we note that the current grid infrastructure in Sri Lanka appears to be incapable of supporting significant growth in the wind power sector. Grid infrastructure in the country is relatively old. Substations along the west coast and in the southern region of Sri Lanka also have low transmission capacities and could create difficulties in transmitting wind energy. We believe it is these deficiencies in transmission capacity that led the Ceylon Electricity Board to conclude that the national grid is unable to accommodate wind capacity exceeding 7% of peak load.