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Clearly inadequate — Power firms plan to pump HK$10b into wind farms, but they’ll do little to make the city greener or its skies cleaner

South China Morning Post — 14 March 2010

Hong Kong’s two power companies are planning to spend HK$10 billion on offshore wind farms, but it will do little to reduce carbon emissions or clean the air, environmental scientists say.

CLP Holdings, Hong Kong’s largest power company, plans to build what will be one of the biggest offshore wind farms in the world – generating 200 megawatts a year – at a cost of almost HK$7 billion.

The wind farm, located 10 kilometres off Sai Kung and comprising 67 wind turbines 120 metres high, will produce less than 1 per cent of Hong Kong’s electricity output and reduce its carbon dioxide emissions by 1.4 per cent.

Meanwhile, Hongkong Electric Holdings recently submitted an environmental impact assessment for a HK$3 billion wind farm to be built between Lamma Island and Cheung Chau that would generate 100MW of power – enough for 50,000 households.

The government has already passed the impact assessment for CLP’s wind farm, but the Hongkong Electric project is still awaiting approval.

Hongkong Electric says the project would produce the equivalent of 1 to 2 per cent of its current electricity output for the city – about 0.25 to 0.5 per cent of Hong Kong’s total electricity consumption.

The company says the project would enable it to reduce the amount of coal it burns by 62,000 tonnes a year and as a result reduce its carbon dioxide emissions by 150,000 tonnes a year.

Hong Kong generated 43.4 million tonnes of emissions in 2007, according to the International Energy Agency. That means Hongkong Electric’s wind farm would cut the city’s CO2emissions by 0.4 per cent. So, for about HK$10 billion, the two wind farms would produce at best about 1.5 per cent of Hong Kong’s electricity and reduce its carbon dioxide emissions by less than 2 per cent.

“If people believe that wind farms will make a serious contribution to reducing Hong Kong’s carbon emissions, they are misinformed,” says Bill Barron, who teaches in Hong Kong University of Science and Technology’s environment department.

Although carbon dioxide is a greenhouse gas, it is invisible and does not contribute to Hong Kong’s dirty air. At the atmospheric level, as opposed to street level, the city’s air is polluted by regional smog, which the Environmental Protection Department says is caused by emissions from transport and power stations in the Pearl River Delta and Hong Kong.

Most of the locally generated pollution is produced by the two power companies – the worst pollutants being sulphur dioxide and nitrogen oxides, neither of which are listed in the Kyoto Protocol as greenhouse gases. They are considered local pollutants.

Hong Kong and the Guangdong provincial government in April 2002 reached a consensus to reduce sulphur dioxide, nitrogen oxides, respirable suspended particulate and volatile organic compounds in the Pearl River Delta by 40, 20, 55 and 55 per cent, respectively, from 1997 levels by 2010, These are the government’s main emissions targets.

Hongkong Electric says that as a result of burning less coal, its wind farm would reduce emissions of sulphur dioxide and nitrogen oxides by 520 and 240 tonnes, respectively. Based on Hong Kong’s 2007 emissions, this would amount to a reduction in emissions of sulphur dioxide and nitrogen oxides by 0.8 and 0.25 per cent respectively. CLP says its wind farm will reduce sulphur dioxide by 54 to 60 tonnes, and nitrogen oxides by 394 to 440 tonnes.

In total, Hong Kong’s wind farms would reduce sulphur dioxide emissions by about 0.8 per cent and nitrogen oxides by about 0.7 per cent.

So why are Hong Kong’s power companies spending so much money on projects that will have a negligible effect on the city’s carbon footprint and air quality?

The wind farms are in part a response to the target set out in the government’s First Sustainable Development Strategy for Hong Kong, released in 2005.

This report – produced by the Council for Sustainable Development, whose chairman was the then chief secretary, Donald Tsang Yam-kuen – called for 1 to 2 per cent of Hong Kong’s electricity to be generated by renewable energy by 2012.

But the power companies are not legally bound by this government target.

The other key driver for the power companies to build offshore wind farms in Hong Kong is the scheme of control, the regulatory framework which governs them.

Unlike most developed countries – which have open and competitive arrangements for the production and distribution of power – Hong Kong still clings to the scheme of control system introduced in the 1960s that allows the city’s power companies to operate as two separate monopolies.

Around the same time, the government also granted monopoly franchises to the bus, power and telecoms sectors. Hong Kong’s economy was developing fast, and the government wanted to encourage badly needed investment in electrification in order to support growth.

It wanted to guarantee a stable power supply and provide incentives to power companies to make long-term investments in Hong Kong.

The scheme turned Hong Kong’s electricity market into one of the most profitable in the world. The scheme is reviewed and renegotiated every 10 to 15 years. The current scheme of control began last year.

The previous scheme permitted the power companies to earn an annual rate of return on depreciated net assets of 13.5 to 15 per cent – double the rates of markets such as Australia and Britain.

Before the previous scheme of control expired in October 2008, the idea of abandoning the scheme was floated, along with introducing third-party competitors from the mainland.

At the same time, power companies came under fire from business, which said the utilities charged too much for their power compared with other countries. The utilities were also blamed for their perceived part in air pollution, which became a subject of serious concern within the community around 2004.

These factors helped the government to negotiate the current scheme of control on less favourable terms for the power firms.

It will run for 10 years rather than 15 and has a lower permitted rate of return – 9.99 per cent – on assets that use conventional resources such as coal and gas to generate electricity.

The current scheme also differs from its predecessor in that it allows a return of 11 per cent on renewable energy assets and includes financial incentives for exceeding emission targets or fines for failing to reach them.

But the scheme of control’s key characteristic remains – it encourages power companies to overinvest in assets. The more assets a company has, the more it is allowed to earn.

“Under the scheme of control they can gold-plate the power station, which is why we have so much excess generating capacity,” says Simon Powell, head of sustainable research at CLSA.

The result is that Hong Kong has a Rolls-Royce power supply, with the companies maintaining 50 per cent more capacity than needed to meet peak demand.

So Hongkong Electric has peak demand of 2.5 gigawatts but has the installed capacity to produce 3.7GW of electricity, while CLP has peak demand of 6.5GW and a capacity of 13.6GW.

The power plants run at about 55 per cent of their capacity.

That means Hong Kong has a highly robust power supply and rarely suffers blackouts. It also means that its tariffs are somewhat higher than places such as Singapore and Britain, but cheaper than Tokyo.

So Hong Kong’s power companies have no need for additional generating capacity and CLP on occasion sells power to the mainland from its Hong Kong plants.

However, the lower permitted returns under the current scheme of control have resulted in significantly lower earnings for the power companies. CLP’s 2009 net profit fell by 12.9 per cent to HK$8.5 billion. Earnings from its Hong Kong business fell 21 per cent, despite a 1.7 per cent increase in local sales. Hongkong Electric’s 2009 net profit declined 17 per cent to HK$6.7 billion from HK$8.03 billion in 2008.

Building wind farms offers power companies a modest increase in assets while generating a good rate of return.

The cost of producing 1MW of electricity from offshore wind farms is three to five times the cost of producing 1MW from coal, which, from a scheme of control perspective, makes them attractive.

“From an internal rate of return perspective, wind farms are a very profitable proposition,” Powell says.

While wind farms would boost the firms’ earnings, some analysts say it is unlikely tariffs would also rise, which adds to the appeal since it reduces the likelihood of public and Legislative Council criticism and increases the chances of government approval.

Other experts are not so sure.

Pierre Lau, managing director and head of Asia-Pacific Utilities Research with Citi, estimates Hongkong Electric’s capital investment will increase from HK$48 billion to HK$51 billion by the end of 2015, even without building the wind farm.

“Before calculating the wind farm investment, the additional capex [capital expenditure] will allow Hongkong Electric to increase tariffs by about 5 per cent,” he said.

“If we include the HK$2.5 to HK$3 billion wind farm project, there can be another 6 per cent rise in electricity costs.”

Hongkong Electric spokeswoman Elaine Wong would not say whether the company would raise tariffs in the next few years. She said spending on the wind farm would occur in phases so the impact on tariffs would be limited. “In addition, as no fuel will be required, costs should be saved,” Wong said.

The Environment Bureau said it had not yet received an investment proposal from Hongkong Electric, but the government would consider a range of factors – including environmental impact, tariffs, renewable energy policy and economic benefits – in making its decision on the wind farm.

“It is our objective to promote wider use of renewable energy while protecting consumer interests,” the bureau said.

While some are cynical about the motives of the power companies, analysts say they are behaving in the best interests of their shareholders.

“They are following the price signals and policy targets set by the government,” says Stephen Oldfield, a utilities analyst with UBS.

Critics say the government’s renewable energy targets are little more than window dressing in response to criticism that it is doing little to move Hong Kong in the direction of a sustainable economy in a world moving increasingly in this direction.

“They [wind farms] look good in brochures and improve the government’s image when it speaks at international forums,” one analyst said.

Others are more charitable towards the government, saying it is not in a position to do much given that Hong Kong does not have much space for large solar panels, or have lots of agricultural waste for generating biomass power.

“If you want a renewable energy target then building some offshore wind farms is probably the best you can do in Hong Kong,” Oldfield says.

But analysts say that if the government is serious about reducing emissions it needs to do more than build a few wind farms. Most believe this means speeding up the replacement of coal with gas-fired power stations. Natural gas produces half the CO2 and nitrogen oxides emitted by coal burning and produces hardly any sulphur dioxide.

But it is roughly twice the price of coal. The higher fuel costs, together with the cost of installing gas turbines or retrofitting coal-fired turbines, will put more upward pressure on tariffs.

Arguably, Hong Kong has been slow to do what Europe has done in moving to gas as a base load supply and using coal for peak requirements. But there have been concerns over the reliability of supply in Hong Kong.

CLP, which steadily reduced its emissions of pollutants in the 1990s, had to increase coal generation after it became concerned that the gas reserves on which it relied from a field off Hainan were being depleted faster than expected.

Analysts say there is now ample supply, with Hongkong Electric already getting supplies via a pipeline from southern China. CLP will also start getting gas piped in from the mainland for its Castle Peak power station over the next few years.

But the cleanest power from an air pollution perspective is nuclear, since it produces near zero emissions.

In September last year, the government approved the extension of CLP’s contract with the Guangdong Daya Bay nuclear power station for another 20 years.

Under the current contract, which expires in 2014, CLP receives 70 per cent of the power station’s output – about one-third of CLP’s power supply and about a quarter of Hong Kong’s total consumption.

It is possible Hong Kong could get electricity from future nuclear power stations being built on the mainland.

The combined generating capacity of both companies is currently 65 per cent coal and 25 per cent gas. But given overcapacity, the actual breakdown is different.

The power firms are also in the process of fitting scrubbers to their coal-fired units, which reduce emissions of pollutants such as sulphur dioxide and nitrogen oxides but increase carbon dioxide emissions since they use more fuel.

It is clear that Hong Kong does not need the additional capacity of wind farms and that replacing coal with gas or nuclear power would be significantly more effective than wind in cutting carbon emissions.

Some analysts say the scheme of control should have been restructured to give power firms a higher rate of return for using gas instead of coal. Hong Kong-based think tank Civic Exchange said in its analysis of the current scheme of control that the government has failed to deliver an integrated energy policy. “As a result, it is unclear how the revised scheme of control will support other policy initiatives,” Civic Exchange said. “This represents a missed opportunity in terms of ensuring that the electricity companies are rewarded for supporting goals that are important to Hong Kong society.”

But radical changes to the scheme of control and the way power firms operate are difficult for the government to enact since they involve taking on vested interests such as the Kadoorie family that controls CLP and Li Ka-shing, who controls Hongkong Electric.

Barron is unimpressed with the government’s commitment to renewable energy and emissions reduction. He says green credibility is much easier to get via the power firms than by, for example, requiring lower plot ratios or spaces between buildings for land sales. “I don’t see them, for example, planning infrastructure for a warmer climate and more expensive energy,” he said. “That’s too big a step for them because they can’t be bothered yet to be doing that.”

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