Report of the President and COO

RBT2013

Richard B. Tantoco
EDC President and COO

“EDC will become the global benchmark for sustainable practices in renewable power generation as we grow the business on a global scale and pave the path to a low carbon future.”

 

Dear Stakeholders,

We are in the midst of opposing forces, headwinds and tailwinds occurring simultaneously.

 

The tailwinds that help propel us come from the broad recognition now that global temperatures have warmed as a result of the accumulation of carbon in the atmosphere. The scientific community largely agrees that this is causing what is known as the “greenhouse effect” or the trapping of the sun’s heat, which otherwise would have escaped had the carbon not been so highly concentrated in the atmosphere.

 

As a result of this, there has been a dramatic shift in some parts of the world where renewable energy has been prioritized. This is positive for our business and augurs well for our future prospects. According to the World Bank, for the first time in history in 2015, the USD170 billion invested in renewable energy (RE) outstripped the USD110 billion invested in coal and natural gas. This trend is expected to continue as the costs of solar and wind go down.

 

However, there are headwinds from the collapse in the prices of coal and oil over the last 36 months. As the parts of the world increasingly shun carbon in general and more specifically coal, here in the Philippine market, there is an apparent preference of the country for coal given its “artificially low prices.” I emphasize the word artificial because coal plants have many “hidden costs,” such as the damage to the environment and the ill effects on the community. Professor Jonathan Buonocore of Harvard University estimates this to be in the range of 9.4–26.9 US cents per kilowatt-hour (kWh), or PHP 4.3–12.4/kWh in the U.S.A.

 

In this context, our main line of business, geothermal, is challenged by coal given the baseload versus baseload pricing comparison. In 2015 alone, we  reduced  prices to our customers in response to competitive forces, resulting in substantial loss of margin, at a time when our assets require capital expenditure (CAPEX) for upgrades to make them more resilient against typhoons. We have had to reduce prices again in 2016. It is against this backdrop that I am making my report to you this year.

 

While the company’s revenues increased by 11 percent to PHP34.4 billion in 2015, our recurring net income attributable to equity holders of the Parent went down 4 percent to PHP8.8 billion. The increase in revenues is attributed to the first full-year of operations in 2015 of the newly rehabilitated and upgraded 140-megawatt (MW) BacMan units and the 49.4-MW Nasulo plant, which contributed PHP4.2 billion and PHP1.3 billion in revenues, respectively.

           

However, higher operating expenses at our Leyte geothermal power plants, and typhoon proofing investments in BacMan and Leyte eroded our margins. Insurance premiums increased significantly due to previous equipment damage and business interruption (one among them being Super Typhoon Yolanda). Foreign exchange losses also contributed to this year’s reduction in net income.

 

Despite these challenges, EDC remains focused on its vision to become a global leader in geothermal energy and strengthen its leadership in renewable energy in the Philippines. In the pursuit of this vision, I would like to sum up the year’s performance by underlining three key, business- strategic areas for our sustained growth: (1) Investing to improve the performance of our geothermal power generating assets, (2) Diversifying our renewable power portfolio, and (3) Applying optimal technology to our business.

           

Improving Performance of Our Existing Geothermal Assets

 

With the exception of BacMan, EDC’s assets are at “mid-life” and require CAPEX investments to maintain reliability levels. These investments are expected of prudently operated facilities. Investing in our existing operations is what we call a “front domino,” something that needs immediate focus and action. Unplanned outages contributed to about PHP1.5 billion in foregone revenues in 2015, and as we invest in our facilities, these losses should be a thing of the past.

 

Strengthening our existing assets is a necessary, strategic investment for EDC. Both the impact of climate-related hazards and the geography of our project sites have made us vulnerable, particularly to typhoons. We completed several typhoon-proofing projects this year, particularly the  installation of new typhoon-resistant cooling towers in both BacMan and Leyte, which have been designed to withstand wind speeds of up to 300 kilometers per hour (kph). All the  other  planned  improvements in the control rooms and buildings were also completed and are expected to mitigate operating risks significantly. On top of these measures, we have on hand sufficient cooling tower spares to restore our assets should another Yolanda happen. We simply don’t want to take any more chances.

 

To improve plant reliability and site resiliency, we are employing engineering solutions such as improvements in the metallurgy of our turbine rotors and blades, and using advanced stress relief methods in manufacturing.

 

We are also retrofitting and upgrading our geothermal plants. The PHP4.3 billion Tongonan power plant rehabilitation is now on its second and final phase, with the largest cost components already contracted with Siemens for the control systems integration and Mitsubishi Hitachi Power Systems for turbine-generator. We are looking forward to the full rehabilitation and retrofitting of the Tongonan units starting second half 2016, and all works should be completed by early 2017.

 

Diversifying Our Growth

 

Second, diversifying our power portfolio is key to spreading our risk and building a complimentary CAPEX deployment model among the different renewable energy technologies. We continue to grow through our technology and global diversification as we galvanize the use of low-to-no carbon sources.

 

With the successful construction and operation of the 150-MW Burgos Wind Project in Ilocos Norte and the 4.16-MW Burgos Solar Power Plant, we now have two forms of renewable energy on one site simultaneously generating power and earning under the government’s feed-in tariff system (FIT).

 

On April 13, 2015, the Energy Regulatory Commission (ERC) issued a Certificate of Compliance (COC) for Burgos Wind, entitling the wind farm to the FIT rate of PHP 8.53/kWh from November 11, 2014 to November 10, 2034. For the first nine months of 2015, however, it was subjected to a grid constraint that limited the dispatch of the wind farms in Ilocos Norte, including Burgos. The constraint was finally lifted in end-September when the National Grid Corporation of the Philippines (NGCP) commissioned its new Laoag-San Esteban transmission line. We lost about 85 gigawatt- hours (GWh) in production or about PHP721 million. As a result, Burgos Wind contributed only PHP2.4 billion to revenues in 2015.

 

Internationally lauded, Burgos Wind reaped seven international awards and citations granted in 2015, including the coveted Asia- Pacific Renewables Deal of the Year award by Project Finance International (PFI), Trade Finance 2014 Deal of the Year Award, 2015 Asia Projects of the Year Awards from Power Engineering International, and the Best ECA- backed Green Deal Award of Trade and Export Finance.

 

It was also conferred  a  citation by PFI “on the  basis  of  the timely construction, cost control, economic importance of the asset, and the challenging location of the construction site,” where EDC was the  only  wind  project  cited  and the only one from the Philippines. Burgos Wind remains the largest wind project in the country.

 

The Burgos Solar Project is EDC’s first venture into solar power, contributing PHP49.3 Million of revenues this year. The ERC also issued a COC for the 4.16-MW Burgos Solar I with a FIT rate of PHP9.68/kWh from March 5, 2015 to March 4, 2035. Following this successful execution of Burgos Solar I, we had issued a Notice to Proceed (NTP) last September for the 2.66-MW Burgos Solar II. The project was commissioned in January 2016

 

We are committed to expanding our geothermal business overseas in our concession areas in Peru, Chile, and Indonesia. In Mariposa, Chile, we deferred the exploration drilling campaign due to global market downturn in 2015, resulting to the project’s difficulty to secure off-take agreements with a viable tariff. We remain intent on securing our growth projects in Latin America as we continually work together with the local regulators and guide geothermal policy development.

 

Locally, we similarly put on hold the BacMan III project due to challenging market conditions. However, we will continue to invest time and resources to develop geothermal, wind, and solar assets and commercialize  these  as  the opportunities arise.

 

There is work to be done  with the  regulators  and   legislators in the country to make them recognize that geothermal needs to be prioritized. The Philippines committed a 70 percent reduction in its carbon emissions by 2030 when compared to business as usual, and to achieve this, priority has to be given to geothermal, which is the only source of baseload renewable energy in the country. Solar and Wind are intermittent and operate between 11 to 27 percent for solar and 20 to 30 percent for wind in a year. Geothermal can achieve a 95 percent availability and is truly capable of baseload operations as it has proven over the years.

 

Future geothermal will require a modest feed-in tariff, nowhere near where wind and solar are today but in reality is significantly cheaper when the costs of intermittency are factored in. For example, solar can lose up to 85 percent of its generation with a 3- to 6-second “shade event.” When a large source of supply is dropped off  quickly, the very stability of the grid is at risk. The way this is addressed now is that NGCP purchases “ancillary services” like load following and frequency regulation energy from plants that are already running and can kick in to cover for the intermittency in real time. In contrast to that, geothermal is a 24 x 7 producer of clean energy and does not require incremental costs because it is neither intermittent nor seasonal.

 

The three categories of intermittent renewable integration costs — one, adequacy costs, or the cost of ensuring that the power system has sufficient capacity to meet peak loads; two, balancing costs, or the cost of ensuring that the power system can respond flexibly to demand changes at any given time; and three, interconnection costs, or the cost of linking sources of supply to sources of demand — are estimated by the International Energy Agency (IEA) to vary approximately in sum from 1.1–1.7 US cents/kWh in the European Union (EU) and 1.3–1.9 US cents/ kWh in the U.S.A. Translating these to Philippine Peso would result in additional costs of PHP0.60/kWh to PHP0.90/kWh for Wind and Solar FITs or about PHP9.43/kWh for Wind and PHP10.58/kWh for Solar. If geothermal will be apportioned a rate that is 40 to 45 percent below these FIT rates, then it would spark the renaissance of geothermal.

 

Applying Optimal Technology to Our Business

 

We believe that using innovation and technology to address  our most significant and pressing issues will be the key drivers that will take our core geothermal business to the next level. As early as six years ago, we instructed our geoscientists and engineers and to be more daring and innovative. While we are pleased with the progress made to date in testing and using appropriate technologies to achieve more effective and efficient operations, we realize we have a long way to go. Let me cite a few examples.

 

After Super Typhoon Yolanda totally damaged our cooling towers, we asked our suppliers, to custom engineer and design our equipment to withstand wind speeds to 300 kph. Aside from changing fan stack manufacturing technology from spray lay-up method to resin transfer molding (RTM), we have also changed all cooling tower fan drive shafts from steel to carbon fiber, which is lightweight, sturdier, and corrosion-resistant.

 

For both steamfield and power plant operations, we have collaborated with international industry giants resulting in improved reliability factors and longer life cycle  of our geothermal assets. For Upper Mahiao power plant, for instance, we are now using OEM-designed steam turbine rotors with new metallurgy which can better withstand stress corrosion cracking, as well as sustain performance, with less degradation between maintenance inspections.

 

For our  pentane  feed  pumps, we have collaborated with two manufacturers to re-engineer legacy designs from 5  to 4-stage design to reduce power consumption and maintenance costs. We have tapped two other suppliers  to  upgrade  metallurgy of pump casings and other components of hot well pumps to further reduce maintenance costs, sustain performance, and improve equipment reliability.

 

For drilling operations, we have now reduced drilling days by 17 percent (benchmarked against 2010) despite the more challenging conditions present, and this has resulted in PHP42 million per well savings. This was mainly due to higher penetration rates as a result of improved drilling technologies such as the use of custom designed drill bits, downhole mud motors, and aerated fluids drilling. The costs of drilling new wells and maintaining existing ones have been significantly reduced after we changed well designs to include “tie back” completions and implemented the use of surface boring machines to “top hole.” This approach has reduced costs by (an additional) PHP10 million per well compared to using a conventional drilling rig.

 

However, given the sustained challenges that we face going forward, we will channel significant resources toward aggressively searching for technologies and tools that will address our most pressing problems and reduce our greatest costs and risks.

 

Leading the Country to Decarbonization

 

There is a bright spot on the horizon and the rest of the world has already seen it. Worldwide, countries, policy makers, legislatures, local governments, companies, banks, funds, developers, groups, and individuals are making  the  choice to go low-to-no carbon.

 

Very large financial institutions such as the World Bank and Calpers have said that they will not fund any more coal. ENGIE, one of the largest energy companies  in  the  world has begun to divest all its coal investments. The RE 100 composed of the world’s most influential companies committed to 100% renewable power by 2020.

 

Various   governments   around the world have made serious commitments to go low  carbon by shifting to renewables in the coming years. Hawaii has set an ambitious target of sourcing 100 percent of its electrical energy from renewable energy sources by 2045, and the U.K. will get rid of all its coal by 2025. China has announced that it will start a carbon market by 2017 and price carbon by 2020.

 

Chile has declared an ambitious commitment of 70 percent renewable and clean energy  in its energy mix by 2050. Being a country that is situated along the “Pacific Ring of Fire,” Chile will benefit from geothermal energy that provides clean, renewable power and can very well help it meet its commitments.

 

While our own policymakers have taken limited steps to move in a similar direction, EDC needs to help fill a gap that will raise awareness and generate positive policy changes. EDC needs to be the lead voice in this debate and advocacy.

 

On behalf of our Board, I would like to thank all our employees for demonstrating their solidarity with the company and the hard work that they’ve rendered every single day. I would like to thank our customers for their firm belief in EDC, and our shareholders and other stakeholders whose trust and support we count on. I hope that, collectively, we can hold both ourselves and our government accountable to the climate commitments made in Paris at COP21.

 

The past year had its challenges, but they also sharpened our focus on what matters as the business transforms and grows.  Ingrained in our core values and principles, and working  closely   together with all our stakeholders, EDC will become the global benchmark for sustainable practices in renewable power generation as we grow the business on a global scale and pave the path to a low carbon future.