An Analysis of Foreign Direct Investment (FDI) and Energy Generation in Costa Rica's Wind Energy...

8/9/2019 An Analysis of Foreign Direct Investment (FDI) and Energy Generation in Costa Rica's Wind Energy Sector - Opportu

1/24

THE YALE SCHOOL OF MANAGEMENT

An Analysis of Foreign Direct Investment

(FDI) and Energy Generation in

Costa Ricas Wind Energy Sector:Opportunities and Challenges

Mian M. Hussain

7/26/2010


2/24

2

Acknowledgements

It would not be untrue to say that I was somewhat daunted by the task at hand when I landed in Juan

Santamara Airport at the end of May. I recognized that the only way I would succeed in completing this

project within the short timeframe available was through the support of those intimately familiar with Costa

Rica and its intricacies. Over the course of my time here, I have had the privilege of meeting and working with

young (and some not so young!) leaders from all walks of life, all of whom have helped to make theexperience a very memorable one.

I would like to use this page as a podium to express my deepest gratitude to all of these individuals. The

number of people I had the privilege of meeting makes it difficult to mention each one but I would like to

take a few words to thank Roberto Jimnez for providing this truly wonderful opportunity and to Ricardo

Ziga and Ral Guevara for being gracious enough to provide an office from where I could complete this

work. I would also like to thank all of the members of the Batalla Abogados team for being such wonderful

hosts. Of particular note are Ignacio Nachito Guzmn and Oscar Osquitar Sandoval who taught me the

importance of Spanish diminutives. I shall henceforth be known as Mianito.

Many of the insights gained through this project came from individuals with an intimate knowledge of energy

and environmental issues in Costa Rica. These include Pablo Jenkins (Clean Technologies Cluster), RafaelMonge (Clean Technologies Cluster), Sal Kierszenson (Clean Technologies Cluster), Esteban Bermdez

(Clean Technologies Cluster), Felipe Castro (Clean Technologies Cluster), Sofa Ziga (Batalla Abogados),

Albn Snchez (Procomer), Carola Medina (Procomer), Catherine Reuben (CINDE), Jay Gallegos

(MesoAmerica), Lawrence Pratt (INCAE), Arellys Cedeo (La Republica), Timothy Lattimer (U.S. Embassy),

Maricela Muoz (U.S. Embassy), Daira Gmez (CEGESTI), Sylvia Aguilar (CEGESTI), Mauricio Castro

(Fundecooperation), Marianella Feoli (Fundecooperation), Kate Cruse (U.K. Embassy), and Astrid Gomez (U.K.

Embassy). Without your support and guidance, this work would not have been possible thank you!


3/24

3

Executive Summary

An analysis of the wind energy industry in Costa Rica was conducted in order to determine opportunities for

Foreign Direct Investment (FDI) as it pertains to the manufacturing of wind turbine components. A secondary

analysis focused on the wind energy generation market was also conducted in order to highlight the

challenges of meeting growing demand as well as the opportunities for energy exportation through Central

America.

It was determined that Costa Rica has the potential to build power electronics and transformers for wind

turbines. These compromise roughly 5% and 4% ofthe total cost of the turbine which is estimated to be 1.2

million per MW. Poor transportation infrastructure in Costa Rica was cited as a factor which added to the

challenge of manufacturing turbine components, however. Additionally, it was found that the transportation

costs associated with larger components i.e. blades made them less attractive economically.

The wind generation market, when viewed from a purely economic standpoint, was discovered to offer wide

ranging opportunities. The rise in electricity demand both within Costa Rica and elsewhere in Central America

were cited as key factors driving growth in this market. Additionally, the seasonal offset of wind and rainfall

was noted to be a key feature in favour of wind powers candidacy in Costa Ricas future energy portfolio.

Furthermore, the facilitation of energy transfer through Central America via SEIPAC was cited as a factor thatcould facilitate the implementation of energy as a regional export.

The biggest challenges to the implementation of business models based on the sale of wind derived energy,

both domestically and through Central America, were determined to come from the misalignment of stated

public policies and actual economic policies. In particular, it was noted that the current pricing schemes

offered by the government owned organization was insufficient to drive investment from the private sector.

The growing demand within the country and current budget deficit also raises questions about whether the

government will be able to meet the future demands of the country without support from the private sector.

The key recommendations as a result of this work are two-fold. With regards to manufacturing, Costa Rica

should work directly with turbine manufacturers in order to assess the possible implementation of power

electronics and transformers manufacturing facilities. With regards to wind energy generation, the

government should take steps to ensure that wind energy forms a larger part of Costa Ricas future energy

portfolio. In addition, it should reassess its economic policies with the aim of creating an economic

environment conducive to attracting private sector investment.


4/24

4

Background and Motivation

The project that is the subject of this paper was conducted on behalf of the Clean Technologies Cluster of

Costa Rica. This not-for-profit organization is a coalition of organizations and individuals in Costa Ricas clean

technology sector whose objective is to help spur economic growth in Costa Rica, one of Latin Americas

fasting growing economies, while keeping sight of the environmental impact that invariably accompanies

economic growth. The Clean Technologies Cluster does so by creating green-collar jobs through thefollowing three-way strategy:

(1) Attracting Foreign Direct Investment (FDI) in the clean energy sector

(2) Advocating for environmentally responsible policies at the national level

(3) Assisting environmental entrepreneurs launch new businesses

The focus at the onset of this project was the first of these three strategy components attracting FDI in the

clean energy sector. The study initially aimed to analyze various types of renewable energy sources including

but not limited to biofuel, solar energy, wind energy, and energy efficiency. As the project evolved however,

it became clear that there are enormous challenges in competitively producing biofuel. Limited time and

resources therefore led us to narrow our focus on wind energy which we believe holds enormous potential as

a renewable energy source within Costa Rica.

An equally important item that we learned over the course of the project was that some of the largest

obstacles facing the future of clean energy production and distribution within Costa Rica were not technical

but related to the misalignment of stated public policies pertaining to renewable energy and actual economic

policies and incentives. In light of this finding, this paper aims to address not only opportunities related to FDI

in energy equipment manufacturing but also to highlight some of the challenges to economic growth

stemming from current economic policies. The final product of this work thus not only addresses the first of

three objectives outlined by the Clean Technologies Cluster but also highlights some of the challenges in

meeting the second objective.

Attracting Foreign Direct Investment

The economic impact of attracting FDI can be divided into the explicit and implicit components. The impact

on the Gross Domestic Product (both net and per capita) is clear; by bringing raw materials to build

components which will then be exported, companies add value to the Costa Rican economy. An example of

this can be found as recently as 1996 when Intel announced it would invest $300 million1

in a chip

manufacturing plant outside of San Jos, Costa Ricas capital. At the time of this paper, Intel accounted for

20% ofCosta Ricas exports and nearly 5% of its GDP2.

The impact on the national economy of a given industry is not limited to businesses that are directly involved

in the production of goods and services in that industry, however. As an example, one may consider

agriculture in Costa Rica; companies directly selling agricultural goods, both domestically and internationally,

account for 10% of GDP3. But an examination of the economic impact of indirect players such as those in the

agricultural supply chain i.e. transporters, distributers, etc., reveals that the impact of agriculture is much

higher: 30% of GDP.

In a similar vein, the impact of foreign investment on the economy is not limited to the direct contribution of

goods or services produced. Both job creation in the manufacturing sector and technology transfer are often

cited outcomes of FDI. The impact of the latter is particularly worth considering given that the building of

competency in manufacturing clean energy machinery can be applied to other industries in the form of

technology transfer. Indeed, a number of interviewees in both the private and public sectors cited Intel as


5/24

5

one of the factors driving the Costa Rican workforces growing technical competency in the manufacturing of

electrical equipment.

Finally, the growth of Costa Ricas global profile as a destination for FDI, whether in the clean energy market

or otherwise, is another outcome of this endeavour. One of Costa Ricas greatest assets of and also one of

the hardest to quantify is its reputation as a country actively combating climate change. It is our hope that

this work will encourage economic and public policies which will further strengthen Costa Ricas profile in thisregard.

Reassessing Energy Policies

While not an initial objective of this study, an analysis of public policy pertaining to wind energy production

and its resultant economic impact were deemed vital and hence are included in this paper. The motivation to

include this subject matter came from the recognition that the exportation of wind derived energy within

Central America could add tremendous valueto the Costa Rican economy.

On a related note, we learned that while the current energy needs of Costa Rica were being met through

hydroelectric energy, there were questions surrounding whether future needs would be met given the rise in

energy demand that accompanies economic growth. To this end, economic policies that did not take intoconsideration future demand could significantly hamper economic growth. It is our hope that by highlighting

some of the challenges that Costa Rica will face, we will provide an impetus to Costa Rican leaders to devise

and implement a set of economic and public policies that will effectively address these issues.


6/24

6

Project Overview

In line with the first objective of the Clean Technologies Cluster of Costa Rica attracting FDI in the clean

energy sector the initial aim of this study was to systematically analyze various clean energy production

technologies in the context of their suitability to Costa Rica. In devising a solution, we bore in mind that the

answer to this question would be two-way; we would not only have to determine which industries were best

suited to Costa Rica based on the requirements needed to make them successful but we also had to focus ourattention on Costa Ricas strengths and limitations. A cluster for clean technologies would only be sustainable

and competitive in the long term if both of these requirements were met.

We initially aimed to analyze the potential of three types of clean energy biofuel, solar, and wind in Costa

Rica. However, the final version focuses on the suitability of wind energy. This is for three reasons. First, it

became very clear early on during the study that in the context of FDI and export driven business models,

Costa Rica would not be competitive as a destination for biofuel production as this type of energy production

requires large areas of inexpensive, fertile land and an inexpensive, unskilled labour force4. Vis-a-vis countries

like Brazil, neither of these factors exists in the right quantity needed to reach the economies of scale

associated with large scale biofuel production.

Secondly, we felt that it was necessary to author a paper that rigorously analyzed the potential of cleanenergy through interviews with individuals from private and public sectors, primary sources of analytical

data, and secondary sources such as similar studies. Such an endeavour required a considerable analysis of

information and ultimately could not be completed within the limited timeframe available. We therefore

decided to analyze the energy source which was the most promising from both the supply and demand sides

of the equation: wind.

Finally, a number of discoveries led us to recognize that some of the greatest challenges in the

implementation of clean energy solutions in Costa Rica lied not in a lack of resources material, human, or

natural but rather inconsistencies between stated public goals and economic policy. Of particular concern

was the pricing policy and economic stipulations put in place by the Costa Rican government which we felt

were not conducive to growth. An assessment of wind energy in Costa Rica would be incomplete if it failed to

highlight this problem and provide recommendations to the Clean Tech Cluster aimed at addressing this

issue.


7/24

7

Market Definition

Size, Growth, and Alignment

An initial assumption upon which we based this study was that the most effective way in which we could

positively impact the Costa Rican economy would be through exports. As a country of fewer than 5 million,

Costa Rica is a fairly small market and not one that would attract significant investment. The government

owned monopoly in the energy market (Costa Rican law does not allow private companies to directly sellenergy within the country) further adds to the challenge of finding suitable buyers for manufacturing

renewable energy generation products and services.

A natural question which then arises from the stated hypothesis is: What types of manufacturing and/or

services should we aim to attract? The answer to this question must address both the demand and supply

sides of the equation. That is, does the market favour the production of such good(s) and/or service(s) i.e.

there is sufficient unmet demand, and are the requirements for a successful venture currently present in

Costa Rica?

While the reputation of Costa Rica as a leader among developing nations in the field of climate change policy

cannot be understated, any decision made by a foreign company to invest in Costa Rica whether in a

product or a service must be based on sound financial reasoning as measured by Return on Investment(ROI) or analogous measures. The value added to the Costa Rica economy through FDI would come from the

value differential value of goods/services exported net the value of inputs. This necessitates that the target

segment base be large (it is for this reason more than any other that the export markets are the focus of this

study) and growing at a healthy pace. While the Costa Rican government provides incentives to attract FDI

such as the exemption of income taxes for the first eight years for companies present in Zonas Francas5

or

free trade zones, other incentives such as free land or land subsidies are not provided. The decision to

invest in the production of manufacturing facilities must therefore make economic sense under the

applicable conditions.

The supply side of the equation determining whether the selected good(s) and/or service(s) could be

produced in Costa Rica in its current economic standing is of equal importance. Attracting investment

would mean conducting a rigorous analysis to ensure that the necessary variables needed to make a venture

successful were indeed available. These could include labour (both quantity and quality), transportation

infrastructure, raw materials, land, and a legal framework to name a few. Adding to the challenge is that this

list of variables may differ greatly between one type of product and another. For instance, the production of

biofuel is driven nearly exclusively by the cost of agriculturally suitable land and unskilled labour6.

Alternatively, the production of mechanical components for wind turbines depends far more on the

availability of skilled labour and suitable transportation infrastructure7.

Market Growth

Information on the demand side of the equation i.e. determining whether a market exists for the production

of goods and services was obtained through a variety of public sources. Since the focus of this project is

export, the anticipated global demand of various clean energy technologies was viewed. This is shown in

Figure 1.


8/24

8

Figure 1 Expected growth in market size of various clean energy sources8

Broadly speaking, the growth between the three segments solar (including both PV and thermal), biofuel,

and wind is relatively balanced. It is estimated that the wind market in 2019 will be worth over $100 billion

dollars9. One of the objectives of this study is to highlight a segment within the wind energy manufacturing

industry where Costa Rica holds a competitive advantage so that it can be an active player in this market.

A number of interviews10

conducted in early phases of this project highlighted the strength of the

manufacturing sector within Costa Rica. The success that Costa Rica has enjoyed with computer chips (Intel)

and medical devices underscore the countrys core competency in manufacturing. What was less clear was

whether the labour force could also be a source of competitive advantage in the manufacturing sector as itpertains to wind turbines.

Importance of Export

The Costa Rican population of 4.5 million would hardly be attractive for companies targeting the North

American and/or European markets. Adding to the challenge is the government owned monopoly in the

energy market which considerably diminishes Costa Ricas attractiveness to foreign investors.

Competitors

In competing for FDI, countries are often grouped geographically. Thus, Costa Ricas competitors as

traditionally defined include other countries in Latin America and the Caribbean. While the competingcountries for Intel in the mid-1990s were indeed in Latin America

11(Brazil, Chile, and Mexico), the underlying

reasoning need not always apply.

A somewhat more accurate definition of competitor would be based on a combination of economic criteria

such as population and GDP per capita (purchasing power parity). However, even this approach fails to take

into consideration the means by which GDP is created. Indeed, a number of Latin American countries which

have a higher GDP (PPP) per capita than Costa Rica can attribute that difference to an abundance of natural


9/24

9

resources rather than a more advanced economic makeup. The most notable examples of this are Chile

whose wealth in minerals and Venezuela whose oil reserves give them a GDP per capita (PPP) of $14,341 and

$12,201 respectivelysignificantly greater than Costa Ricas $10,579.12

A more appropriate comparison would involve analyzing the makeup of the countrys economy agricultural,

industrial, or service based. In the vein, a country that would be far more analogous to Costa Rica is Ireland

which went through a similar period of economic development in the 1960s. Of particular note is that theIrish Industrial Development Authority redirected the focus of economic growth away from traditional

activities such as agriculture towards technology while simultaneously implementing public and economic

policies to attract FDI. As a result of this economic growth, Ireland now serves as an offshore platform for

the European Union (EU) specializing in service based economic output and light manufacturing. Not

surprisingly, nearly all of Irelands exports at the time went to Europe, with approximately 90% going to

Britain alone.

Costa Rica could potentially serve in a similar capacity for the North American market if it successfully

executes similar economic policies. A linear regression of two variablesthe countrys educational level and

its economic performance point out that Ireland was, for in a considerable period of time, lagging its peers.

A similar analysis done today illustrates that Costa Rica is in a similar situation; the level of economic

development, in particular in the service sector, lags behind where it should be based on education level.


10/24

10

Foreign Direct Investment in Turbine Component Manufacturing

Preliminary research indicates that the manufacturing and design of components for wind energy technology

may be the most promising area of investment. The key drivers in this group are not land and unskilled labour

as is the case with biofuel but skilled labour and manufacturing infrastructure.

One of Costa Ricas greatest sources of competitive advantage is its workforce, specifically its value per wagerate in medium level technological jobs, a fact highlighted by the recent success in the production of

computer chips and medical devices. Other types of services where the Costa Rican workforce has

successfully carved out a niche that befits its skill set include assembly and test services as well as moderately

intensive research.

One of the key challenges facing Costa Rica today is the quality of the port infrastructure where the country is

currently ranked 128th

in the world13

. While plans are currently underway to develop an improved facility in

Puerto Limn in Costa Ricas Caribbean coast, it is unclear whether this project will fully address this issue at

a competitive cost and whether it will be in operation quickly enough to attract FDI in the immediate future.

Perhaps the greatest single challenge resulting from transportation pertains to blades. In spite of the

significant capital cost of wind turbines approximately 1.2 Million per MW transportation of componentscan increase the cost by up to 20%

14. It is for this reason more than any other that companies in the turbine

generation business are moving towards a vertically integrated supply chain one that minimizes the needs

to transport large, expensive components.

In addressing the question of FDI, we considered the possibility of manufacturing blades in Puntarenas where

we believed that the skills and infrastructure were available due to the presence of a yacht manufacturing

facilities. Because yachts are composed primarily of fibreglass, the same material used to made turbine

blades, we felt that there was the possibility that an industry focused on blade manufacturing could be set

up. However, the cost associated with shipping blades to Europe and North America raised questions about

cost competitiveness.

Figure 2 Cost of wind turbine components15


11/24

11

This limitation led us to focus on components with a high cost density defined to be the cost per unit

weight. The value of this parameter is underscored by some of the goods which Costa Rica has successfully

integrated into its economy i.e. computer chips and medical devices. In this vein, the most promising turbine

components are the power convertor and transformer, which make up 5% and 4% of the cost respectively.

The skill set needed to accomplish this type of manufacturing are present in the country as a result of the

educational system and the technology transfer that has taken place as a result of Intels presence. The hightechnical competence of the Costa Rican workforce in the manufacturing of electrical hardware further lends

weight in support of this argument.


12/24

12

Wind Energy Production: Opportunities and Challenges

At the initiation of this study, our focus was on developing a strategy to attract FDI in the manufacturing

sector irrespective of whether this pertained to energy derived from solar power, wind, or biofuel. A number

of factors that came to bear as this project evolved, in particular insights from individuals in both the public

and private sectors with an intimate familiarity with Costa Rica, led us to shift direction so as to include not

only wind turbine component manufacturing but also on wind energy generation.

Of particular note was a meeting with MesoAmerica Energy, a branch of a private equity firm which has

experienced first-hand the challenges of running a wind energy generation business in Costa Rica. Prior to

this meeting, our interaction with organizations involved in energy production in Costa Rica had been limited

to individuals and organizations from the public sector i.e. CINDE, Procomer, U.S. Embassy, U.K. Embassy,

Costa Rican government officials, etc. and academic organizations i.e. INCAE. A balanced assessment of the

energy industry made it imperative that we obtain insights from the private sector as well.

Wind and Rain: A Supply Side Offset

A key observation pertaining to energy supply is that not only does Costa Rica have an abundance of both

wind and hydroelectric energy, but that their respect supplies are offset by approximately half a year. Thus,the peak season for windthe dry seasons in Costa Rica which lasts from December to May is also the

season in which hydroelectric electricity is more limited due to a lack of rainfall. Conversely, the wet season

which lasts from June to November offers an abundance of rainfall needed to supply hydroelectric

powerplants.

This seasonal offset provides a type ofhedge as renewable forms of energy are available year-round.

Unfortunately however, the latter resource is currently being used to supply the vast majority of the

countrys clean energy supply. This presents a number of significant risks including questions about the

supply vis-a-vis growing demand, an alleviated risk of energy shortage, and opportunity costs associated with

unused resources.

Figure 3 Wind and rainfall patterns in Central Valley (Alajuela) and Guanacaste (Liberia)

Figure 3 shows the wind and rainfall patterns in Alajuela and Liberia. There are a three behind the selection

of these two locations. First, the most reliable meteorological data for wind and rainfall is collected at

airports. The two largest airports in Costa Rica, Juan Santamara and Daniel Oduber Quirs, are located in

Alajuela and Liberia respectively. Secondly, it is of particular importance to examine wind and rainfall in the


13/24

13

Central Valley as this is home to the majority of the Costa Rican population. Lastly, the generally favourable

wind conditions found in Guanacaste merit the collection of data in this province. In reality, the production of

wind generation facilities would not necessarily be in Liberia but rather in a location with ideal wind

conditions.

Although rainfall and wind patterns provide a good indication of the seasonal offset of these two sources, a

more accurate assessment of renewable energy can be made by analyzing the power generation potential ofthese two sources over the course of a year. Not surprisingly, the amount of hydroelectric and wind turbine

power available mimics the rainfall and wind patterns respectively. The variation in supply by season ensures

that Costa Ricas energy supply year-round is clean. Unfortunately, however, nearly 80% of the total energy

supply in Costa Rica comes from hydroelectricity alone16

while the balance comes from a variety of other

sources including biomass, geothermal, and wind.

Figure 4 Annual hydroelectric and wind energy potential17

Figure 5 Energy generation portfolio of Costa Rica18

Alleviated Risk of Single Supply

A secondary but related item worth pointing out here is that rainfall, like any natural resources, cannot bepredicted accurately and consistently. Using only one renewable resource to meet the vast majority of the

countrys energy needs therefore exposes the country to the risk of energy shortage in the event that the

volume of rain over a given period of time falls significantly below expectations.

The production of energy production facilities as a result of this risk is not without precedent. As an example,

one may consider the energy complex near Volcan Arenal which hardly used thermal generation shortly after


14/24

14

it was constructed in the early 1980s. Subsequently, its use increased to a maximum of 17.4% in the year

1994 due, in large part, to a severe drought19

.

The issues of growing demand and unpredictable supply notwithstanding, Costa Rica also needs to address

opportunity cost of not harnessing wind energy. The wind generation capacity of the country, while

tremendous, is arguably the largest renewable resource whose potential has not yet been fully realized.

Aggressive investment in the harnessing of this renewable energy supply may very well hold the key tomeeting the growth in future demand that the country will experience, reduce the risk of energy supply

constraints stemming from unusual weather patterns, and provide sustainable growth to the economy by

way of energy exports.

The potential for export driven revenue from energy generation may bear fruit if the sum of the current

energy supply stemming from hydroelectric powerplants, when combined with wind energy, exceeds the

demand within the country. Currently, approximately 8 million people in Central America do not have access

to electricity20

. The supply mismatch between Costa Rica and its neighbours may very well manifest itself in

the form of economic opportunity if the government is willing to either directly invest in the generation of

wind energy or encourage development from the private sector through economic incentives.

Finally, it is worth mentioning that a significant barrier that would otherwise have discouraged foreigninvestment in Costa Ricas energy market a lack of grid interconnectivity between various Central American

countries has been alleviated through the Sistema de Interconexin Elctrica de los Pases de Amrica

Central (SIEPAC). The removal of this technical obstacle effectively means that barring any political or

economic disputes, export of wind generated energy through Central America could be effectively

implemented.

Wind and Rain: Domestic Demand Side Analysis

The issue of seasonal supply notwithstanding, the prevalence of wind during the dry season also lends

credibility to greater investment due to issues related to the demandside of the equation. While the energy

demand in Costa Rica continues to grow, the general pattern of annual electricity demand has remained fairly

steady; the demand for energy tends to be greatest between November and April with a significant drop

between the months of May and August. The maximum instantaneous electricity demand recorded in

2008 was 1526 MW and occurred in the month of February 21, the same month at which wind power has

historically been at its seasonal peak and rainfall at its seasonal trough. A quick view of Figure 4 and Figure

6 demonstrates that the electricity demand pattern is somewhat inconsistent with the availability of

hydroelectric power which accounts for most of Costa Ricas supply. Conversely said, the electricity demand

tends to more closely follow the pattern of wind energy availability although the amount of variation in wind

potential is greater.


15/24

15

Figure 5 Annual energy demand in Costa Rica (2005 2008)22

The framework of demand side analysis is not limited to annual assessments, however. Factors of human

behaviour over the course of a 24-hour day reveal a fairly reliable assessment of energy needs that lendcredibility to the case for greater wind energy production. The energy demand historically has tended to

reach a plateau at approximately 10am after which it remains relatively steady until 6pm at which time a

three hour peak commences.

An often cited criticism of wind23

is that unlike hydroelectric energy which can be converted to electricity at

will, it is only available when the wind is blowing. To test whether this observation was significantly

detrimental to the case for greater investment in wind, we conducted an analysis of wind data in Liberia,

Guanacaste over the course of the six months that make up Costa Ricas dry season. The result was

surprising. The data, shown in Figure 7, indicated that wind speed reaches a plateau at around 11am and

remains fairly steady until approximately 6pm. Thus the supply is fairly steady through the course of an

afternoon. Furthermore, the data indicates that this pattern holds true for all six months of the dry season

although the actual wind speed varies. The general prevalence of this energy source during the day whenmost of the Costa Rican population is active strengthens the argument for investment in this area.

A secondary but related argument against the above cited criticism comes from the impact that greater wind

energy production would have on hydroelectric energy supplies. Currently, hydroelectric power is the energy

source of choice during both the wet and dry seasons. Greater investment in wind energy generation

during the dry season would have the effect of lessening the need to use hydroelectric power during this

time of year. This, in turn, would help maintain higher water levels in reservoirs during the dry seasons

than has traditionally been the case. In this manner, the availability of backup energy supplies will be

greater thereby providing an alternative source should there be a decrease in wind for a sustained period of

time.


16/24

16

Figure 6 Daily energy demand in Costa Rica (January December)24

Figure 7 Wind speed variation in Liberia, Guanacaste during dry season

Domestic Demand Side Growth

The seasonal offset between wind and rain along with the daily and seasonal demand variation are not the

only concerns that warrant a re-evaluation of winds place in the Costa Rican energy market. Of particular

interest in the long term is the growth of the Costa Rican population and economy, both of which will lead to

a rise in energy demand.

From 1990-2007, electricity demand in Costa Rica grew at an average annual rate of 5%. In 2008, the rate of

growth slowed to 2% due to the country's economic slowdown resulting from the global economic crisis. The

projection of demand over the course of the next two decades, illustrated in Figure 8, demonstrates the

increase in energy demand as the country grows.


17/24

17

Figure 8Growth in Costa Ricas energy demand (2010 2030)25

Three scenarios for growth in energy demand are shown with a variation in the assumptions used. The

growth in demand is shown assuming low, average, and high growth rates. The price of electricity has been

kept constant in all three cases as a means of simplification. In practice, one can expect consumers to alter

their energy consumption behaviour based on price, however.

It is expected that the energy demand to rise by 50% and 150% in one and two decades time respectively

based on the average rise scenario. A more aggressive increase in energy consumption would lead to a

demand that is four times higher in 20 years than it is today. While Costa Rica currently meets its electricity

demand using renewable sources to generate over 90% of its electricity requirements, it is unclear whether

the sources currently being used will be enough to meet future needs.

Demand Rise in Transportation

The issue of demand is not limited to energy in the residential and industrial sectors. Currently, 100% of

Costa Ricas transportation is powered by hydrocarbons26

. In an article written by Laura Chinchilla in La

Nacion, she outlined a framework to address the issue of energy to power the country in the future. One of

the objectives outlined was to have a transport system that relies only on clean energy27

. This goal is based

on a model whereby vehicles which currently use hydrocarbons such as petroleum and diesel are replaced by

vehicles which must be electrically charged.

Invariably, switching all of Costa Ricas transport vehicles from fossil fuel to electric will lead to a massive rise

in energy demand. The ambitiousness of this goal is only amplified by the relatively short timeframe by whichthe Chinchilla government aims to obtain carbon neutrality: 11 years at the time of this study. Unless the

government intends to incorporate clean and readily available sources of energy such as wind into the

portfolio of energy resources, it is likely that this goal will either only be partially attained or will come at the

cost of a steep increase in prices resulting from a demand surge. A third scenario would, of course, be the

status quo; a large and ever increasing number of hydrocarbon based vehicles contributing to the countrys

carbon emissions.


18/24

18

Energy Demand: An Export Perspective

As we explored the challenges and opportunities in Costa Ricas energy market, one of the items we

discovered of significant economic potential was the energy landscape in other Central American countries.

The lack of availability of electricity in other countries in the region, the projected economic and population

growth and with it growth in energy demand, and the price disparity (only amplified by the difference in

average incomes) all help to paint a picture of significant economic impact to the Costa Rican economy

through energy export.

Figure 9 Energy availability and cost in various Central American countries

28

While nearly all of Costa Rica has access to electricity, the energy situation in other Central American

countries is somewhat mixed. Of particular interest is Nicaragua where only 61% of the population has access

to electricity29

. In the entire Central American region, approximately 8 million people still do not have access

to electricity.

This picture is incomplete without some words on the cost of electricity in Central America. Broadly speaking,

the price of electricity in other Central American countries is significantly higher than in Costa Rica. The price

of electricity in Nicaragua, for instance, is nearly 50% higher in both the residential and industrial sectors

vis--vis Costa Rica30

. As the 40% of the Nicaraguan population which currently does not have electricity

obtains access, we can expect a rise in demand. Unless this rise coincides with a proportional rise in supply,

we can reasonably expect the price disparity to increase. This may present the opportunity for Costa Rica toexport energy. For Costa Rica to make use of this opportunity, the country will have to harness supply

sources that will not meet but exceed the domestic demand. As some of the points highlighted earlier in this

paper indicate, this will be challenging.

Figure 10 Growth in energy prices in various Central American countries (1994 2007)31

The model of regional electricity export is one that must overcome potential technical, legal, political, and

economic issues. With the recent completion of the Sistema de Interconexion Electrica para America Central

(SEIPAC) agreement, many of the technical and legal issues have effectively been addressed. Thus, what


19/24

19

remains for SIEPAC to serve as a platform for transporting energy are the necessary economic criteria, in

particular the supply and demand mismatch across borders and resulting price disparity that will provide the

incentive for a country like Costa Rica to sell energy to its neighbours. What remains unclear is what roles the

private sector and public sector, in particular ARESEP and ICE, will play in any agreements to sell energy.

Figure 11 Sistema de Interconexion Electrica para America Central32

Public Policy Challenges

Although a number of macroeconomic and geopolitical factors stable democratic government, responsible

environmental stewardship (and perhaps even more importantly for FDI, theperception of responsible

environmental stewardship), strong and multiple renewable energy supplies, and a lack of oil and natural gas

(often cited as causes of the resource curse) have positioned Costa Rica to reap economic rewards

through its location and climate, much of this potential remains unfulfilled. While this failure cannot be

attributed to any one factor alone, part of the cause is poorly drafted and executed public policy. In

particular, there are three major concerns with regards to Costa Rican public policy on the national level as it

relates to clean energy production:

1.) Public policy cannot be effectively implemented without first understanding the goals2.) Public policy cannot be pursued in a vacuum3.) Goals must be extremely specific and timed

Fully understanding the objectives

At the heart of public policies environmental, political, social, or otherwise lie objectives. These must be

defined clearly and early on in a manner that makes their purpose clear. To date, a number of energy related

economic policies that have been proposed or put in effect have been done so without complete

consideration of what the objective really was. A number of examples within the renewable energy industry

can be cited as evidence.


20/24

20

One of the keys to becoming competitive generating electricity through wind turbine farms is to utilize

economies of scale to dilute certain fixed costs. While the cost of turbines varies by the number used in a

wind farm (ignoring the possibility of discounts associated with large orders), fixed costs such as the cost of

grid connection are independent of the number of turbines used. Currently, Autoridad Reguladora de

Servicios Pblico (ARESEP), the Costa Rican governments branch responsible for regulating prices of public

utilities does not permit any company to build plants with an output capacity greater than 40MW (roughly

equivalent to 20 to 30 wind turbines), a fact that may step from concerns that large energy generating plantsmay threaten the amount of influence ARESEP can exert on the market.

This limitation in size has the effect of thinning the operating margins of wind farms which, in turn, dissuades

foreign investment from Costa Rica in two ways. Firstly, it sends the wrong message to the investor

community by implying that the government is not only uninterested in pursuing clean energy policy but it is

actively taking steps to prevent its implementation. Secondly, it makes Costa Rica a far less attractive

destination to invest in by way of lowered Return on Investment (ROI) or alternatively, increasing the Internal

Rate of Return (IRR) the required rate to break even on a project. Current IRR rates of wind energy

generation plants in the United States are approximately two thirds of what they are in Costa Rica: 11% vs.

17%33

.

The price of electricity that ARESEP is currently paying $0.059 per KW-hr is currently enough to only covercosts for certain wind farms. The price and longevity of contracts is therefore severely detrimental to

attracting foreign investment as it exposes energy providers to fluctuations in the Consumer Price Index (CPI)

i.e. inflation, as well as the exchange rate between the Coln and the U.S. Dollar. One possible means

through which this could be addressed is a feed-in tariff, a mechanism that would help accelerate Costa Rica

towards the attainment of 100% grid parity through the implementation of renewable energy sources such as

wind. Included in such a provision would be guaranteed grid access, long-term contracts, and prices which

reflect the cost of production of wind energy and make investing in this field attractive for private sector

firms.

A discussion of the Costa Ricas energy market would be incomplete without some comments on the broader

issue of government owned monopolies. Access to electricity, like clean water, is necessary not only to

improve a nations standard of living but also to spur economic growth. The generally high demand

inelasticity associated with items necessary for survival such as clean water makes them very attractive for

entities in the private sector who are motivated by economic profit. Free market economies where

companies will price goods and services to maximize their profit creates the risk that prices may fall out of

reach of many people thereby not only impeding economic growth but also adversely impacting the average

persons standard of living. Taken to an extreme, such scenarios can lead to social unrest as seen in

Cochabamba, Bolivia in the aftermath of water privatization in 1999.

Government own monopolies significantly mitigate this risk by placing a cap on the price such that energy

becomes affordable to the vast majority of society. This provides the necessary supply needed to grow the

economy and improve citizens quality of life. However, such an economic framework must function in such a

manner that it not only efficiently distributes energy to the masses but does so without losing sight of

incentives that will encourage economic growth. Many of the Costa Rican governments policies as applied to

clean energy production, while effective in distributing energy to the masses, fail in this regard.

Policy in a Vacuum

Public policy as viewed through legislation alone is almost never enough to make an impact. Rather, policy

must be pursued in conjunction with economic and social incentives in order to bring change. While Costa

Rica has very publicly made efforts to market itself as an environmentally responsible and socially progressive


21/24

21

country, it has not put in place many of the necessary economic incentives needed to reach the goals implied

from stated policies. This is clearly demonstrated in the relationship that ARESEP has hitherto had with wind

energy generation firms.

Effectively implementing the stated public policies necessitates changes in economic and/or business policy

to provide the right conditions to meet these objectives. Improving coordination between government

agencies to create competitive rates for clean energy production, increasing the size limit of wind farms, andthe implementation of a feed-in tariff are all economic measures that are better aligned with the objective of

achieving carbon neutrality without compromising economic growth.

Arguably the single best source of information on the future of the Costa Rican energy market is outlined in

the National Energy Plan (Plan Nacional de Energa). A number of key points highlighted in this plan point to

the governments desire to move towards a fully renewable energy portfolio. However, an objective

assessment of the policies raises questions about whether these policies will be effective given the lack of

economic incentives. Some of the more important points as they pertain to wind energy are highlighted

below.

The first objective highlighted in the Principles and Objectives section states the need for Security of

energy supply.This goal is repeated in the fourth of five strategic objectives which calls for Increasing the

diversification of energy supply. It is difficult understand how such a goal can be accomplished if nearly all

of the renewable energy in Costa Rica comes from one source: hydroelectric power. As the lack of rainfall in

1994 highlighted, the country will remain at risk if no action is taken to expand the portfolio of energy

beyond one source. Furthermore, the seasonal offset of wind and rainfall that was highlighted earlier in this

study only raises more questions about the governments actual strategy vis-a-vis its stated objectives.

The second point in Principles and Values emphasizes the need for indigenous sources of energy. It is the

second wordsources which most urgently needs to be addressed. While hydroelectric power is indeed

indigenous, it makes up such a large part of the energy portfolio that it would not be drastic to say that

sources could easily be replaced by the singular form of the word: source.

The final point in the Principles and Values section calls for Cooperative effort between public and

private sectors. The amount of influence that ARESEP and ICE have on the market renders the private

sector a relatively insignificant part of the energy picture in Costa Rica. However, the rise in demand that

country will experience in the next two decades raises questions as to whether the public sector will be

capable of meeting the challenges alone. Adding to this challenge are some of the budgetary constraints that

the government is currently facing.

Goal Definition

While Costa Rica obtains nearly all of its electricity through renewable means, the justification of the

breakdown of energy sources remains unclear. A more effective and efficient public policy would entail a

clear breakdown of energy sources in addition to clear justification for whythose breakdowns are what theyare . Indeed, an even better solution would involve different breakdowns depending not only on region but

also by time of year. For instance, Guanacaste with its abundance of wind may opt for this energy source to

take up a much larger share of the total energy supply. Similarly, the energy breakdown of the country may

be such that a larger proportion of energy is generated in hydroelectric powerplants during the wet season

and a smaller proportion during the dry season when wind provides the majority of energy.


22/24

22

Conclusions and Recommendations

Foreign Direct Investment in Turbine Component Manufacturing

The greatest challenges to the development of a wind turbine manufacturing industry in Costa Rica come

from a lack of adequate transportation infrastructure and the high cost associated with shipping large

components overseas. It seems highly unlikely that Costa Rica will be able to resolve these obstacles in the

near future, an absolute requirement for the development of a sustainable economic cluster.

The most promising area within wind turbine manufacturing business where Costa Rica could successfully

compete is the production of high cost density components. Specifically, the power convertor and

transformer units which constitute approximately 5% and 4% of the cost of a turbine are the best candidates.

The countrys success in the development of electric chips lends credibility to the production of these

components as does their relatively small size vis-a-vis blades. Before any decision to invest in production

facilities is made in Costa Rica however, a more detailed analysis of cost breakdown of subcomponents

should be conducted.

Wind Energy Production

The key recommendation from the study of energy generation detailed in this report is very clear: Costa Ricaneeds to invest aggressively in wind energy generation. The substantiation for this recommendation comes

from analyzing both the supply and demand sides of the equation. The more challenging part is determining

and executing a set of steps to attain this goal. We believe that while a number of challenges lie ahead for

Costa Rica in the context of the energy market, the key to solving many of them lie in aligning economic and

public policies. The following recommendations will help to address these issues:

1. Reassessment of PricingAlthough the Costa Rican government has successfully brought affordable energy to its people, this

success has come at the detriment of the investment from the private sector. As the demand for

energy grows, the private sector may very well hold the potential to address this challenge. For it to

play an active role, the government will need to provide economic incentives starting with a more

competitive pricing model for energy generation.

2. Reassessment of Private Sector in Energy GenerationThe production and distribution of energy can be broadly broken down into three phases:

generation, transportation, and distribution. Currently, the Costa Rican government has control of all

three of these stages. While the second and third stage can be kept under government control in the

foreseeable future, the first generation needs to be liberalized. It is doubtful that the growth in

demand will be addressed by the public sector alone. Allowing the private sector to generate more

electricity will help address the supply side of the equation. This strategy, however, will have to take

place in conjunction with the reassessment of pricing mentioned above as incentives for private

sector firms to enter this market must be present.

3. Further Analysis of Energy ExportsIn the longer term, the Costa Rican government should strongly consider energy export via SIEPAC if

it can successfully meet national demand. Because the models of energy growth are subject to

changes, it is remains to be seen where future energy supply will remain relative to demand. In the

event that the country does produce more energy than required, the decision to export energy

should be made in lieu of lowering production to demand levels.


23/24

23

About the Author

Mian Hussain is an MBA student (Class of 2011) at the School of Management at Yale University. He

completed this project over the course of June and July, 2010 as part of his MBA summer internship. His work

was funded exclusively by Yale University through the Deans Fellowship Grant and Emerging Markets Grant.

He can be reached via email at [email protected]


24/24

24

1Building a Cluster: Electronics and Information Technology in Costa Rica Harvard Business Review Case 9-703-422

2LavanGuardia Website - http://www.lavanguardia.es/premium/publica/publica?COMPID=53410660334& ...

ID_PAGINA= 22088&ID_FORMATO=9&turbourl=false3Por Qu Invertir En Centroamrica? Roy Zuiga (INCAE Business School)

4

Interview Lawrence Pratt (INCAE Business School), June 16th

20105

Interview Catherine Reuben (CINDE), June 22nd

20106

Interview Lawrence Pratt (INCAE Business School), June 16th

20107

Interview Jay Gallegos (MesoAmerica Energy), June 30th

20108

CleanEdge Website - http://www.cleanedge.com9

CleanEdge Website - http://www.cleanedge.com10

Interviews Albn Snchez (Procomer), Catherine Reuben (CINDE), Mauricio Castro (Fundecooperacion), Daira

Gmez (CEGESTE), Lawrence Pratt (INCAE)11

Building a Cluster: Electronics and Information Technology in Costa Rica Harvard Business Review Case 9-703-42212

The International Monetary Fund13

The Global Competitiveness Report, 2009 2010 The World Economic Forum14

The Economics of Wind Energy The European Wind Energy Association, March 200915

The Economics of Wind Energy The European Wind Energy Association, March 200916

Plan De Expansion de la Generacion Electrica Periodo 2010 2021 Instituto Costarricense de Electridad17











La Nacion Article http://www.nacion.com/2010-07-04/Opinion/Foro/Opinion2433870.aspx28

Plan De Expansion de la Generacion Electrica Periodo 2010 2021 Instituto Costarricense de Electridad29Plan De Expansion de la Generacion Electrica Periodo 2010 2021 Instituto Costarricense de Electridad

30Plan De Expansion de la Generacion Electrica Periodo 2010 2021 Instituto Costarricense de Electridad



33Interview Jay Gallegos (MesoAmerica Energy), June 30

th2010

An Analysis of Foreign Direct Investment (FDI) and Energy Generation in Costa Rica's Wind Energy...

Documents

Transcript of An Analysis of Foreign Direct Investment (FDI) and Energy Generation in Costa Rica's Wind Energy...