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Finance 663International Finance

Desertec

Desertec: Powering Europe with the Sahara

Finance 663: International FinanceCambell Harvey

2/27/2014

Tsiri AgbenyegaRafael Andreata

Crystal BaiRichard Bethune


Desertec

As the financial crisis heated up in 2008, Europeans kept an eye on the bigger threat of climate change. European governments, utilities and industrial concerns cast about for salvation in the greatest energy resources of the Middle East and North Africa: their solar and wind energy. The smartest minds in Europe assembled an audacious plan to invest nearly €400 billion in renewable energy projects to feed Europe green energy from across the Mediterranean. Would it work?

Background

Desertec Foundation

The DESERTEC Concept shows concretely how the use of renewable energy in deserts and arid regions could lead to the positive further development of global society. The supply of businesses and households with clean, safe power at reasonable prices is crucial to the development of a prosperous society and the creation of job opportunities for development for large segments of the world population.Crucially, clean electricity from the desert is free from CO2 emissions and thus does not threaten the stability of the climate. The Desertec Foundation works in close collaboration with all sectors of society - government, industry, academia and non-governmental organizations (NGOs) - with the aim of bringing all relevant stakeholders together and promoting cooperation for the concept’s implementation.

Between 2003 and 2007, the DESERTEC Concept was developed by an international network of politicians, academics and economists. It was developed by the Trans-Mediterranean Renewable Energy Cooperation (TREC), a voluntary organization founded in 2003 by the Club of Rome and the National Energy Research Center Jordan, made up of scientists and experts from across Europe, the Middle East and North Africa (EU-MENA).

The physicist Dr. Gerhard Knies and HRH Prince Hassan bin Talal of Jordan, the then President of the Club of Rome, were the driving forces behind the formation and development of the network.

In 2007, the results of the DESERTEC studies as well as proposals for action regarding the implementation of DESERTEC in the EU-MENA region (Europe, Middle East and North Africa) were summarized in a WhiteBook, which was presented in the European Parliament by Prince El Hassan bin Talal. In 2008, the drafting of a first version of the Mediterranean Solar Plan of the Union for the Mediterranean was the result of talks with the French embassy and representatives from French ministries. The aim of the Mediterranean Solar Plan is the development of renewable energy projects with a total of 20 gigawatts by the year 2020.

Finally, the DESERTEC Foundation was founded by public figures, private individuals, politicians and scientists from North Africa, the Middle East and Europe with this aim: to support the systematic use of renewables in deserts and arid regions worldwide as laid down in


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the DESERTEC Concept. The German Association of the CLUB OF ROME was and is an important partner and interface for the foundation’s development. The DF is based in Berlin. It is a non-profit and does not pursue any economic interests.

Desertec Industrial Initiative (Dii)

To help accelerate the implementation of the DESERTEC Concept in EU-MENA the non-profit DESERTEC Foundation and a group of 12 European companies led by Munich Re founded an industrial initiative called Dii GmbH in Munich.

The other companies included ABB, Abengoa Solar, ACWA Power, Cevital, Deutsche Bank, Enel Green Power, E.ON, First Solar, Flagsol, HSH Nordbank, Munich Re, Nareva, Red Eléctrica de España, RWE, Avancis, Schott Solar, Terna, Terna Energy SA and UniCredit ( Exhibit 1).

Like the DESERTEC Foundation, Dii GmbH will not build power plants itself. Instead it focuses on four core objectives in EU-MENA:

- Development of a long term roll-out plan for the period up to 2050 providing investment and financing guidance- Carrying out specific in-depth studies - Development of a framework for feasible investments into renewable energy and interconnected grids in EU-MENA- Origination of reference projects to prove feasibility

Desert Power 2050

Dii developed a study called Desert Power 2050, which demonstrates that the abundance of sun and wind in the EUMENA region would enable the creation of a joint power network that will entail more than 90 percent renewables. According to the study, such a joint power network involving North Africa, the Middle East and Europe (EUMENA) offers clear benefits to all involved. The 38 countries analyzed in this study include the EU27, Norway and Switzerland, Turkey, Syria, Jordan, Saudi Arabia, Egypt, Libya and the three Maghreb countries Tunisia, Algeria and Morocco.

An integrated EUMENA power system allows Europe to meet its CO2 reduction targets of 95% in the power sector more effectively and more economically by importing up to 20% of its electricity demand from MENA. Europe thereby saves a total of €33bn annually, or €30 per MWh of power imported from MENA.


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The sheer size of largely unused land and favorable climatic conditions in the MENA region makes it an ideal location for renewable electricity production. The availability of excellent solar resources in MENA is unique. Prime sites can be found everywhere in the region, from the High Atlas and Tell Atlas in the Maghreb to the Asir Mountains in Saudi Arabia. (Exhibit 2)

In a Connected Scenario, a total of 1,087TWh is exported from MENA to Europe. Given that 23TWh also flows in the other direction, from Europe to MENA, the net power trade balance from MENA to Europe is 1064TWh per year of exports. These net exports from MENA to Europe amount to 19% of European demand and 46% of MENA domestic demand. (Exhibit 3 and 4)

Economic benefits of system integration

System integration provides clear economic benefits. The average cost of production in Europe decreases for all technologies in the Connected Scenario (Exhibit 5). The reason is that the most expensive part of the European renewables is substituted by MENA imports with lower costs. For renewables in MENA, on the other hand, costs remain essentially flat when more electricity is produced for export to Europe. Indeed, the potential is so large that the additional demand from Europe can still be satisfied by production at sites with excellent conditions (and thus low costs).

Both MENA and Europe profit from an integrated power system for the entire region, in which 1087TWh of renewable power are exported from MENA to Europe and 23TWh from Europe to MENA. This amounts to a power trade balance of 1064TWh of net exports from MENA to Europe.

Such an integrated system has a system cost advantage of €33.5bn. p.a. over a system in which MENA and Europe fully cooperate to achieve their carbon emission reduction targets (i.e. share a common carbon cap), but without a shared power system (Exhibit 6 and 7).

The cost of transmission across the Mediterranean per imported MWh is 14€/MWh on average. This average value is derived from the total annual cost of €15.1bn and the 1110TWh of net electricity trade across the Mediterranean (Exhibit 7).

There are two reasons for the high savings of 30€/MWh in the Connected Scenario (Exhibit 8):

- The cost advantage of power production from the vast wind and solar potentials in MENA over that of European renewables.- The benefits of integrating a power system over an area of 13.2M km2 (of which 5.5Mkm2 is in Europe and 7.7Mkm2 is in MENA).

Climate Benefits


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In addition to reducing exposure to fossil fuel price volatility, an interconnected EUMENA power system also provides a robust pathway to decarbonization of the power sector. In the case of two isolated systems, the cost of carbon emissions is €192/tonne. This value decreases by more than 40% to €113/tonne if the EUMENA power system is integrated (Exhibit 9).

Implication on country levels

With more than 30 countries involved in the project, we can divide them in three main types of countries: renewables super producers (super producers), renewables scarce countries (importers) and countries with balanced renewables and demand (balancers) (Exhibit 10). Their complementary roles lead to a situation of interdependence across the system, in which no single country is dependent on another but instead each country is reliant on the system as a whole.

Super producers are countries with excellent renewables resources and relatively low demand. Examples of super producers are the Maghreb countries (except for Tunisia) and Libya in the south and Norway in the north. The super producers profit from system integration in two key ways: from a large renewable electricity export industry and from a reliance on the overcapacities of renewables (compared to domestic load) as a means of ensuring their own security of supply at all times of the year.

Importers have high demand and, compared to demand, a limited potential of good renewables resources. This group of countries includes Germany, Italy, and – though less pronounced – also France and Turkey. A lower limit on the electricity self‐supply rate has been imposed in the system so that no country relies on power imports for more than 30% of its supply. These countries import cheap renewable power throughout the year to ensure an affordable sustainable power supply. They benefit not only from the cost advantage of the imported electricity, but also from the optimized allocation of the conventional gas generation remaining under the given carbon emission cap.

Balancers have levels of demand and renewables resources that are largely proportionate to each other. They include Egypt, Saudi Arabia, Syria, Spain, the UK and Denmark. An assessment of renewables potentials must not only be based on the levelized cost of electricity but also on their fit with the load that needs to be satisfied at every point in time. This group includes countries with a range of demand levels. Some have very high demand, such as Saudi Arabia, Egypt and the UK, as well as Spain and comparably small countries such as Denmark, Tunisia and Syria. Many of these countries (Spain, Denmark and Syria) are major transit countries, which profit from their location on an electricity highway to extract or inject electricity into the grid as needed.

Socio-economic effects


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The socio‐economic numbers shows how desert power not only encourages economic growth by providing affordable, stable electricity; but how it contributes directly to socio‐economic benefits, such as the creation of new jobs, the growth of new industries, and economic development in general. The industry related to a system of this size alone can lead to the creation of up to 1,000,000 new jobs ( Exhibit 11).

EU and MENA

Collaboration between EU and MENA on electrical energy integration would have two main benefits: environmental and trade/business.

To avoid climate change catastrophe, the international community agreed that global warming should be kept below 2ºC compared to the temperature in pre-industrial times. In that vein, the EU has committed to transitioning to more sustainable energy sources; they committed to reducing greenhouse gas emissions to 8% below 1990 levels between 2008 and 20121. The EU therefore has the opportunity to increase the proportion of energy from renewable resources by using energy from MENA’s CSP.

The EU has been historically, and remains, the MENA region’s most important trading partner. However, the EU’s share of MENA trade has declined in recent years as the region’s trading partnerships with the rest of the world, especially emerging countries, has increased (Exhibit 121). The MENA region’s most important European trading partners are France, Italy, Spain and Germany; together, they account for approximately 70% of all MENA trade with Europe. Of these countries, France and Italy are the most important trade partners with the region. Germany is a significant source of MENA’s imports but is less important as a destination for the region’s exports. The opposite is true for Spain, which is an important export market for MENA but not an important source of MENA’s imports (Getting Started: pg 41).

Trading between the MENA region and these major EU countries could significantly improve with an energy partnership.

Germany

Germany is the global leader in research into and development of solar thermal power plant technology3. As early as 1984 – 1991, German companies supplied the essential components for plants in California that are still in operation today, and have produced 16,000 GWh of electricity since then. Today, German manufacturers supply the core components for solar fields and power-station units as well as the necessary measurement and control technology. German companies have a very high market share worldwide. Thus, partnership with MENA to produce CSP would benefit the German solar thermal power equipment manufacturing industry.

1 Getting Started: pg 41


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Spain and Italy

Although there’s energy demand in the MENA region, there’s often not enough capital to support major renewable energy projects. One of the only ways for countries in the region to build them is through guaranteed exports of up to 90 percent of the energy generated; this would help cover the initial capital investment. Exporting the green power involves connecting the countries with the sun to consumer countries like Germany by way of long-distance high-voltage power lines. That is expensive, and any country that is to be part of the proposed new grid, like Spain and Italy, can throw a wrench in the works. Due to the high costs of such long-distance grids, often governments have to subsidize some of the project costs to make projects feasible. Spain, produces its own solar and other renewable energy and may not see the need to subsidize this particular high cost project.

France

France relies mostly on nuclear energy to supply its electrical needs; thus, France has technological advantage and capital in nuclear technology. Thus, a movement towards other sources of energy such as CSP may not be in the best interest of the French. In addition to the above discussion, EU countries on the other hand want to be energy independent, thus partnership with MENA could undermine that desire.

Morocco at a glance

Morocco is a country in the Maghreb region of North Africa, with a population of about 33 million2. Its political capital is Rabat, although the largest city is Casablanca. Geographically, this country is characterized by rugged mountainous interior and large portions of desert. 3

The major resources of the Moroccan economy are Chemical (phosphates) and food processing. The production of textiles and clothing is part of a growing manufacturing sector that accounted for approximately 40% of total exports in 2006, employing 42% of the industrial workforce. 4

2 http://www.indexmundi.com/morocco/demographics_profile.html

3 http://www.mapsofworld.com/morocco/geography-and-history/

4 http://www.moroccobusinessnews.com/Sectors/Industry.asp


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For Morocco, unreliable rainfall is a major long-standing problem. In 1995, the country's worst drought in 30 years forced Morocco to import grain and adversely affected the economy. Another drought occurred in 1997, and one in 1999–2000. Reduced incomes due to drought caused GDP to fall by 7.6% in 1995, by 2.3% in 1997, and by 1.5% in 1999. 5

Another major problem for this country is the lack of oil and gas reserve and its heavy reliance on energy imports. Morocco produces small volumes of oil and natural gas from the Essaouira Basin and small amounts of natural gas from the Gharb Basin. 6 Consequently, 96 per cent of Morocco’s energy needs are sourced externally and the country is the largest energy importer in northern Africa. The leading supplier of Morocco’s energy requirements is Saudi Arabia, at 48 per cent. Due to its heavy reliance to external energy resources, Morocco’s energy cost is increasing rapidly with the rise of global energy price. Morocco’s energy bill reached MAD62 billion (approximately US$7.3 billion) and electricity demand in the country is projected to quadruple by 2030.7

Morocco’s Renewable Energy Ambition

Traditionally, Morocco’s electrical sector has been administered by the state-owned authority Office National de l'Electricité (ONE). The two largest electricity power stations at Mohammedia and Jorf Lasfar are both coal fired and most of the coal used is imported from South Africa8. Given its limited natural resources, climate condition and the high growth rate of energy demand (power demand growth of 6.5 per cent a year9), the kingdom is working to diversify its energy sources, especially to develop renewable energy, with particular focus on wind power, solar power and nuclear energy.

Regional Integration

Morocco is gradually integrating its electrical grid with those of its neighbors in Africa and Europe. Maghreb integration has been spearheaded by the Maghreb Electricity Committee, with physical integration initiatives that began in the 1990s. In May 2003, Moroccan representatives met with the Energy ministers from other European and Mediterranean countries to discuss the feasibility of electricity market integration. Tunisia, Algeria, and Morocco acknowledged that they would like to eventually link their electricity systems to the E.U.’s single energy market. In December 2005, Morocco, Algeria, Tunisia and the European Union signed a funding agreement that will

5 World Country Study Guide, International Business Publications, USA; 4 Stg edition (February 4, 2003)

6 Morocco Foreign Policy and Government Guide, International Business Publications, USA (January 1, 2004)

7 http://www.nortonrosefulbright.com/knowledge/publications/66419/renewable-energy-in-morocco#pg_hdr

8 http://www.nortonrosefulbright.com/knowledge/publications/66419/renewable-energy-in-morocco#pg_hdr9

http://www.nortonrosefulbright.com/knowledge/publications/66419/renewable-energy-in-morocco#pg_hdr


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pay for costs related to study the electricity market within the three countries and how they might integrate into the European electricity market.

Sustainability Risk of Governmental Financial Support

The local energy industry has enjoyed government subsidy plans for a long time and it has always been a heavy financial burden on local government. In the short term, these subsidies are helping to ease the limit of this industry’s financial resources but they cannot keep rising indefinitely. With national consumption per capita is expected to rise from the current level of 0.4 tonnes of oil equivalent (toe) to as much as 0.90 toe in 2030, this governmental financial report is facing a massive challenge.

Modeling Morocco

Morocco seemed the ideal location to determine if Desertec could scale up in 2008 because of its high irradiance and proximity to Europe. How should the Desertec investors think about its risks?

Technological Considerations

Concentrated solar power (“CSP”) seemed the best fit for Morocco because of its relatively high capacity factor of around 60% (see Exhibit 13) and Morocco’s abundance of undeveloped desert. Still, the sun could not be commanded to shine. Even when it did shine, about 10% of it was expected to be lost in transmission.10 There were high hopes for CSP, particularly in the Siemens unit attempting to roll it out as a utility-scale alternative to fossil fuel and nuclear plants. Still, it was an unproven technology that had never been rolled out on such a massive scale. Given the rapid efficiency improvements in solar thermal technology, the technology was expected to have no salvage value after the 20-year project life. Operating and maintaining the equipment was expected to consume 1.25% of project costs per annum.

Political Considerations

The German Club of Rome originally backed Desertec giving it strong support in Europe. The project could potentially benefit from European carbon credits, but that market was not stable. Although the majority of power (68%) would eventually stay in Morocco, it was assumed for modeling purposes that all the power would be exported to Europe and paid for in Euros. Institutional Investor published

10 “The Desertec Concept: Sustainable Electricity and Water for Europe, Middle East and North Africa,” Dr. Franz Trieb and Professor Dr. Hans Muller-Steinhagen, 2008.


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country credit rating which can be found in Exhibit 14. Morocco was not known to directly expropriate investments, but southern Morocco was not fully controlled by the central government.

Financial Considerations

Desertec investors were most interested in how much money and how many megawatts to invest in Morocco. Key considerations were Morocco’s capacity for investment and the international cost of capital in Morocco. In total, Desertec investments would reach about €400 billion to produce over one thousand terawatt hours of power annually. However, in 2008, Morocco’s GDP was only $90 billion11 and its installed generating capacity was just about 5,000 megawatts. With transmission costs baked in, each megawatt of CSP was expected to cost about €2.5 million euros. Europeans were expected to pay about €0.05/kWh for the solar power itself and about €0.014/kWh for the HVDC transmission lines.

The investors examined the project cost of capital through the lens of Professor Cambell Harvey’s international cost of capital model. In the beginning of 2008, the 10-year U.S. Treasury risk-free rate was 3.91%. The corporate tax rate was 30% in Morocco.

Commercial Considerations

Siemens, Bosch and other major industrial concerns were providing technology and commercial acumen to the Desertec initiative. This encouraged the World Bank to consider supporting the project in Morocco.

Making a Decision

European politicians, utilities and industrialists considered these various factors carefully. Was Desertec worth the risks? Could it really deliver a reasonably priced, clean energy future?

11 IMF.


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Exhibits

Exhibit 1 – Dii Composition: Shareholders, Associated Partners and CooperationShareholders: ABB, Abengoa Solar, ACWA Power, Cevital, Deutsche Bank, Enel, EON, First Solar, Flagsol, HSH Nordbank, MunichRE, Narev, RED Electrica de Espana, Vorweg Gehen, Avancis, Schott, Terna, Terna Energy, Unicredit, State GridAssociated Partners: AGC, Audi, BearingPoint, Bilfinger, Flabeg, ILF Consulting Engineers, Inmaksa, Intesa Sanpaolo, Italgen, Lahmeyer International, Leoni, Mauri Solare, Shell, SMA, Soitec, TUV SudCooperation: Mesia, Giz, RCREEE, Medgrid, Secretariat of the Union for the Mediterranean, ResMed, Friends of the Supergrid


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Exhibit 2 – Solar resources in the EUMENA region

Sources: Dii 2050 Desert Power, Fraunhofer ISI


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Exhibit 3 – Schematic transmission grid 2050 for electricity system optimization



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Exhibit 4 – Electricity trade between MENA and Europe



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Exhibit 5 – Average cost of electricity production MENA vs. Europe 2050



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Exhibit 6 – Cost savings for Europe and exports for MENA



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Exhibit 7 – Total and interconnector-specific of MENA/Europe transmission



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Exhibit 8 – System cost savings per MWh of net power imports from MENA to Europe



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Exhibit 9 – Electricity from gas and carbon emissions distribution/marginal cost



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Exhibit 10 – Net exporters and net importer in EUMENA



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Exhibit 11 – Preliminary analysis of job effects related to a sustainable power for EUMENA



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Exhibit 12 – China Takes the Lead with MENA Trade Growth

Exhibit 13 Desertec Assumptions12

12 “The Desertec Concept: Sustainable Electricity and Water for Europe, Middle East and North Africa,” Dr. Franz Trieb and Professor Dr. Hans Muller-Steinhagen, 2008.


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Exhibit 14 Institutional Investor Country Risk Premium


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References

1. Dii - Desertec Industrial Initiative (http://www.dii-eumena.com)2. Desertec Foundation (http://www.desertec.org)3. Desertec – (http://en.wikipedia.org/wiki/Desertec) 4. Dii 2050 Desert Power – Perspectives on a Sustainable Power System for EUMENA

(http://www.dii-eumena.com/fileadmin/flippingbooks/dp2050_exec_sum_engl_web.pdf )5. What is the EU doing about climate change?

http://ec.europa.eu/clima/policies/brief/eu/index_en.htm

6. Desert Power: Getting Started. The manual for renewable electricity in MENA

7. Solar thermal power plantshttp://www.renewables-made-in-germany.com/en/start/solarthermische-kraftwerke.html

8. Energy Revolution-A sustainable world energy outlook by European Renewable Energy Council(3rd edition 2010)9. Concentrating solar power in developing countries - Protermosolar –A World Bank study

http://www.protermosolar.com/boletines/51/imagenes/World_Bank_CSP_Financing_Nov2012.pdf

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