Subsidizing lignite plants would create risks for the Turkish economy

Subsidizing lignite plants would create risks for the Turkish economy

Pelin Yenigün Dilek, David Schlissel
The current economic climate creates a dilemma for Turkey’s energy planners. The combination of low fossil fuel prices, increased generation from renewables, excess supply and the liberalization of the energy markets has driven down electricity prices, a benefit for its citizens and businesses. But the Turkish government would also like to decrease the country’s reliance on imported natural gas, and the major alternative being considered is to build new lignite coal plants. The low-price environment means that revenues will not cover the costs of building and operating expensive large power plants. If subsidies are used as proposed, the cost of electricity would rise for Turkish residents and businesses. 

The Turkish Parliament has yet to vote on a bill that would amend the country’s electricity law.  Amendments include a new annual tender pricing system for the electricity generated by lignite-fueled power plants, as well as postponing some of environmental regulations. The details are yet to be announced, but it is clear that the existing and future lignite plants would be able to sell their electricity at prices higher than market prices.      

Turkey’s strategic objective - to diversify its energy sources - is understandable, and controlling lignite reserves within the boundaries of the country is an important benefit. Most countries that rely on coal have similarly sought to rely on their own internal fuel supplies. They nevertheless have learned a lesson that coal comes with a cumulative set of risks that have caused governments to cut back on coal build out plans. The proposed bill, if approved, will have economic, financial, environmental and social consequences affecting Turkey’s macroeconomic path and development quality over the next few decades:

A rapid lignite-fueled power plant build out through subsidies will put upward pressure on the currently low electricity prices: According to IEEFA’s estimations, with minimum price bid on the annual tenders at ¢US8/KWh and market prices at ¢US4.5/KWh, initial annual cost of the subsidy scheme would be $1.1 billion. This cost, if passed through to consumers, would raise the market price of electricity by 19 percent. If the electricity production in lignite-fueled power plants increases as targeted by the government, the annual cost of the subsidies could increase to $2 billion and raise electricity market prices by 29 percent.  

The subsidy scheme would undercut the recent efforts to liberalize the energy markets: Turkey has been liberalizing its energy markets since the 2000s. An electricity grid working on market principles chooses the least cost option first. Adding the new lignite plants would distort this fundamental principle of competitive, market-based pricing. Because of the new financing schemes, the new plants would have to be run as much as possible (even if less expensive options are available for dispatch) in order to pay unavoidable debt costs and avoid default.  

The rapid addition of new lignite-fired power plants would lock in the costs of these plants at a time of slow or declining growth in the demand for power. With lower future growth rates both in GDP and power intensity, the large expansion in new lignite plants would create excess generating capacity whose costs will have to be paid by consumers. 

By trying to improve its energy security through a dramatically increased dependence on lignite and coal, Turkey is choosing a very different energy transformation path than other important emerging economies, which diversify their energy capacity by adding large amounts of renewable resources. Gains from deflationary prices in renewables and efficiency gains on the innovation curve will be incremental in Turkey’s case, while the burden of subsidizing lignite will be carried for the next decade. 

The potential for defaults and/or stranded assets from an increase in new lignite power plants would undermine the banking sector: The deteriorating financial performance of coal companies has already burdened the banking sector. Further exposure to the greater risks inherent in lignite power plants would cause the banking sector to carry a long term imbalance.  

Turkey needs energy security, but adding lignite plants is not the only way to achieve this. Diversifying the energy supply by subsidizing lignite, even if it is domestically produced, is an economically non-viable and financially insecure alternative in a low price environment. Renewable energy, with its technological advantages, deflationary cost structure, and environmental benefits, can provide a better alternative for Turkey on its path to a higher valued-added economy. 

* Pelin Yenigun Dilek is an energy-finance consultant for the Institute for Energy Economics and Financial Analysis (IEEFA), Turkey. David Schlissel is the IEEFA’s director of resource planning analysis.