We discuss energy efficiency and renewable energy from a long term strategic economic perspective.  Energy efficiency and renewable energy  are important with regards to both national productive capital  accumulation and with regards to negotiating foreign investment  capital supply at reasonable  rates. Energy efficiency has the additional advantage of providing a means of building energy sector  capital that is equitably distributed to both high an low income  households.  Both energy efficiency and renewable energy exchange  increased investment in efficient equipment or renewable energy  generation with decreased fuel imports and reduced labor and consumption of Eritrea's environmental biomass stock. Furthermore,  future conversion of the global energy economy to hydrogen-based  energy supply provides the prospect of Eritrea becoming a net  energy exporter through utilization of its vast wind energy  resources on the Southeast coastal areas. The global economic  value of decreased carbon emissions from energy efficiency and  renewable energy can also produce additional income from such  investments at a current market rate of $10 per ton of avoided  Carbon emissions.
 

Introduction

In this paper we present the results of a macro economic impact analysis of efficiency and renewable energy programs on Eritrean long term development. At this stage, we present only very approximate estimates of costs, benefits, and economic impacts.  The reader is cautioned to not use the forecasts in this paper for planning purposes without further refinement with more detailed data. But proceeding none-the-less....

To set the context of our analysis, we summarize the magnitude of different expenses and consumption patterns in the energy sector using data from Eritrean Department of Energy and International Monetary Fund sources.  National purchases of petroleum products in 1997 was approximately 300 million Nakfa per year [IMF, 2000] for about 230,000 tonnes/year for imports, with retail sales about 1.6 times this or 500 million Nakfa. From 1995 to 1997 demand for petroleum products increased approximately 5% per year.   Electricity production on the other hand has increased from approximately 160 GWh/year in 1996 to approximately 210 GWh/year in 1999; an average growth of about 10% per year.  The retail value for this electricity is estimated at between 100 to 200 million Nakfa per year.   Wood consumption was estimated at 1.8 to 2.1 million tonnes/year [Lahmeyer, 1997] in 1996 with consumption growth expected to approximately follow population growth of 3% per year.  Even if we value the biomass used at only 100 Nakfa per tonne, the value of the biomass sector consumption is about 200 Nakfa per year, even though most of this represents non-monetary economic transactions.  In summary the energy sector in Eritrea represents approximately 800 to 900 Nakfa per year of economic activity, and it probably growing at 5% to 7% per year with both population and increasing standards of living.  It therefore represents a very strategic economic development sector, and it is also probably responsible for approximately 10% or more of national imports.

The energy sector also represents a very substantial portion of national infrastructure development.  The Hirgigo power plant and grid expansion project has an investment cost of at least $160 million over about five years.  This represents more than $30 million per year of capital investment expenditure.  In 1997 capital expenditures by the Eritrean government were 19% of gross national product, and capital investments by the private sector were 829 million Nakfa or 14% of GNP.  Energy sector investments are at least 5% of GNP and represent more than 15% of national capital expenditures recently.

The macro economic data described above shows that the energy sector has a very substantial role in Eritrea's development.  Energy sector investments are very important for long term economic strategy for several reasons. One reason is that the size of the energy import expenses and the drain that they provide on national balance of payments.  The second reason stems from the importance that access to electricity has in economic development and improved standards of living.  The effectiveness of electrification in enhancing productivity means that the pace of electricity demand growth will continue at its current rapid rate.  The current electrification rate (fraction of people with access to electricity) in Eritrea is about 20%, and as complete electrification is attained, we can expect national expenditures approaching 500 to 1000 Nakfa per year for electricity supply.  The third factor that makes energy sector development a crucial strategic issue is the fact that current and future biomass consumption is a potentially growing drain on Eritrea's ecosystem.  There is rather limited biomass in Eritrea because biomass production is limited by scarce rainfall.  Therefore energy sector investments that decrease biomass consumption will have a large impact on Eritrea's future environmental capital.

Energy sector investments in the near-term will have a dramatic impact on future energy sector expenses and environmental sustainability.  If there are no improvements in efficiency in the energy sector, then the rapid growth of energy demand will degrade Eritrea's environmental capital and expand Eritrea's already large international trade deficit.   On the other hand if aggressive investments are made in all subsectors of energy development we believe that both substantial environmental rehabilitation can be achieved, and Eritrea's trade deficit can be improved with enhanced national capital accumulation.

The long term question for Eritrean energy sector development is: How do we optimize the long term accumulation of energy capital?  We believe the answer lies in searching for the full spectrum of energy sector development activities that result in net positive accumulation of energy resources and decreases in energy sector expenses.   In this paper we estimate the extent to which efficiency and renewable energy programs and investments may contribute to the development of Eritrea's energy sector and economy in general.

Efficiency and renewable energy increase net national accumulation of capital by decreasing oil imports and biomass harvest.  They also provide enhanced opportunities to obtain access to international sources of capital at concessionary rates.   This arises because of the international environmental benefit that can arise from Eritrean efficiency and renewable energy projects.  As we will describe in future sections, we calculate these international environmental benefits to be worth several million dollars per year.
 

Economic Forecast Model for Eritrea's Energy Sector

We construct a rough model for energy use projections from 1950 to 2050.  In the model we make the following assumptions:

• First that population growth has been 3.0% per year from 1950 to 1996, and that from 1996 to 2050 the population growth rate decreases by 0.042% per year.
• That national income growth is 5% per year and that per-capita income was $200 in 1992.
• That the fraction of the population with electricity increased 0.3% per year from 1950 to 1996.  That the fraction of people with electricity in 1996 was 20%, and that from 1996 to 2050 the fraction of people without electricity decreases 3% per year (when compared to the faction without electricity the previous year).
• That the per-capita biomass consumption is 0.6 metric tons per year, and that all households without electricity use primarily biomass, and half of the houses with electricity continue to be heavy biomass users.
• That electricity consumption is proportional to the fraction of people with electricity service, the population, and inversely proportional to an electric sector efficiency factor that increases 1% per year in the base case.
• That national primary biomass production is 15 million metric tons per year.
• That 30%, 25%, 20%, 15%, 7.5%, and 2.5% of national primary biomass production goes into ecological stocks that have mean lifetimes of 1, 3, 5, 10, 20 and 50 years respectively when undisturbed by household energy use.
• That households harvest their biomass fuel from different ages of stock proportional to the amount of biomass resident in that age of stock.
• That in 1950 (for an initial condition of the biomass stock calculation) the biomass stock is in equilibrium with conditions of no human harvesting.

Data inputs for the model include the estimate of 0.6 Mt/capita biomass consumption, a 1998 population of approximately 3,577,000 (from the UNDP), and electricity consumption of 162.5 Gigawatt-hours in 1996.

With these assumptions we can make rough estimates of future emissions and compare alternative scenarios that may make investments in efficiency and renewable energy development.   In evaluating investment costs, we use a real discount rate of 6% that corresponds to a nominal discount rate of 9% with 3% inflation.  This is approximately the public policy discount rate in Eritrea.

Figure 1: Forecast energy sector expenditures as a fraction of GDP.  Forecasts are provided for both Base Case and Policy Case scenarios.  Base Case scenarios are green lines, and Policy case scenarios are blue lines with symbols.

Figure 1 shows the projected national expenditures under both a base case and high efficiency policy scenario for the energy sector and three subsectors: Oil products, Electricity, and Biomass.  The base case projections are solid green lines, while the high efficiency policy case scenario is shown with the blue dashed lines with symbols. What this figure illustrates is that the energy expenditures in Eritrea might be reduced from about 18% of GDP to about 14% of GDP through long term efficiency programs.  The figure also illustrates the increasing national expenditures on electricity (which are forecast to more than double as a fraction of GDP), the decreasing relative expenditures on biomass, and the roughly flat expenditure on petroleum products (mostly due to the transportation sector).
 

Modeled Efficiency and Renewable Policies

1. Biomass Subsector Efficiency
2. Electricity Subsector Efficiency
3. Petroleum Subsector Efficiency
4. Wind Energy Development
5. Solar Photovoltaic Development

For electricity subsector efficiency, we assume that with no policy intervention only extremely profitable energy efficiency investments are made in the energy sector.  We translate this assumption into an assumed electricity sector efficiency improvement rate of 1% per year with efficiency investments obtaining about a 100% return on investment in the base case.  In the policy case we assume that standards and education can improve the efficiency by about 2% per year and that the average return on efficiency investments is about 50%.  We then calculate the annual investment cost for efficiency by calculating the operating cost savings from the annual improvement in efficiency and dividing by the assumed return rate.

For petroleum subsector efficiency, we use the same assumptions as with the electricity subsector efficiency improvement with some modification.   For the petroleum subsector we assumed petroleum sector efficiency improvement rate of 0.5% per year with efficiency investments obtaining about a 100% return on investment in the base case.  While in the policy case we assume that standards and education can improve the efficiency by about 1% per year and that the average return on efficiency investments is about 50%.  We then calculate the annual investment cost for efficiency by calculating the operating cost savings from the annual improvement in efficiency and dividing by the assumed return rate.

For wind energy development, we assumed that the fraction of electricity supplied by wind turbines increased by 0.25%/year in the base case.  For the policy case we assumed that the fraction of electricity supplied by wind increases 2%/year.  In both cases the starting year for wind development is assumed to be 2005.  The assumed capacity factor for the wind turbines is 30% and the capital investment cost is assumed to be $1500 per kilowatt of rated capacity.

For solar photovoltaic development, we assumed that the fraction of electricity supplied by solar photovoltaic systems increased by 0.01%/year in the base case.  For the policy case we assumed that the fraction of electricity supplied by solar increases 0.1%/year.  In both cases, the starting year for solar development is assumed to be 1993, but the policy case growth rate is not implemented until 2001.  The assumed capacity factor for the solar system is 25% and the capital investment cost is assumed to be $6000 per kilowatt of rated capacity.

Energy Efficiency

General Discussion

Because energy expenses are a greater fraction of expenses for low-income households, efficiency improvements often  contribute to equality and improved distribution of capital.  By decreasing household expenditures with relatively small investment, efficiency improvements can have big impacts on low income households which tend to spend a greater fraction of their disposable income on energy.

Efficiency enhancements lead to greater delivery of end-user energy services for lower levels of fuel expenditures.  This can also have very substantial environmental benefits that can contribute to human resource, health, environmental and agricultural capital.

In the biomass sector in Eritrea, measured efficiencies of biomass fuel use are as low as 7% - 11%, and consumption rates are as high as 2.5 tonnes of biomass per household per year.  This biomass has a carbon content of 1.1 tonnes/year which is valued at about $11-$22/year at $10-$20/tonne Carbon [Prototype Carbon Fund, 2000].  A doubling of household biomass efficiency can therefore be worth  $5-$10/household/year on the international carbon emissions market, and this provides the potential for raising capital for household efficiency improvements at this rate.

Model Results

The economic results are summarized in the following table for the 2000 - 2050 forecast period:
 
 

Subsector	Capital Expense (millions US$)	Retail Savings (millions US$)	Trade Savings (millions US$)	Retail Return Rate	Trade Return Rate
Biomass	$30	$532	$26	247%	15%
Electricity	$29	$198	$98	34%	33%
Petroleum	$42	$339	$226	47%	72%

As can be seen in the above table, the highest consumer benefit (much of it non-monetary) comes from the biomass efficiency programs because this involves the largest number of households and the largest amount of fuel saved.  We assumed in our calculation that the cost of fuel wood is approximately $15 per tonne.

Meanwhile the largest impact on the balance of trade is from the petroleum subsector efficiency programs.  This is because with the large amounts of fuel expended in this sector, a relatively small increase in efficiency can have a large impact on the quantity of petroleum imports.

As is typical for efficiency programs, almost all programs have relatively high returns on investment.  For the balance of trade calculations we assumed that approximately half of the investment cost went to imported materials.  We also included Carbon emissions reduction credits at $10/tonne in the balance of trade calculation.  Such credits are almost entirely responsible for the positive balance of trade and trade return rate of the biomass project which potentially can benefit a total of $24 million from carbon emissions reduction sales.  Because the stove project has mostly non-monetary benefits, and some imported materials, without some crediting for global environmental benefits, it may actually have a negative impact on Eritrea's trade balance.

Figure 2: Forecast biomass stocks under both the base case scenario and the high efficiency scenario. Note how efficiency programs may stop and reverse depletion of biomass stocks.

Figure 2 shows the forecast impact of aggressive biomass efficiency programs in stopping and reversing depletion of Eritrean biomass stocks. With efficiency, biomass stocks may increase by as much as 14 million metric tons (or over 20% higher) in 2035 compared to the base case scenario.
 

Economic Characteristics of Renewable Energy

General Discussion

As can be seen from the above table, the capital costs for the renewable energy sources is higher, especially when viewed in terms of capital costs for average capacity.  This is due to two factors. One is the fact renewable energy plants are simply more expensive than non-renewable plants.  The other is that since renewable energy plants rely on unscheduled resources like the weather, they are usually run at an average capacity that is significantly lower than peak capacity.  For solar energy average capacity is typically about 25% of peak capacity.  Meanwhile for wind turbines average capacity can range from 25% to 50% of peak capacity for good wind sites.

Renewable energy development tends to require a greater technical and human resources capacity than more conventional sources of energy.  This is typically because many of the renewable technologies are newer and younger than the conventional generation technologies that use petroleum products or natural gas. Also for wind energy, the wind turbines that are most effective and efficient are complex high technology machines, that use advanced technologies to manage the mechanical challenges of harnessing energy from highly variable winds.

Many renewable energy technologies are also relatively new to Africa, and therefore renewable energy tends to have global environmental and research/pilot project values. Because of this it may often be possible to obtain partial development subsidies for new projects that test the feasibility of renewable energy applications to developing countries.  The research and development projects can aid in the development of technical human and organizational resources in Eritrea, and can also generate power and energy benefits to the Eritrean economy.  International investments in the research and development aspects of these new technologies can change the feasibility of what might otherwise appear to be infeasible projects.

Wind is one of the fastest growing energy generation technologies with an annual growth of about 25% per year with an estimated installed capacity of 17,000 Megawatts at the end of 2000.  Also for Eritrea, wind energy is potentially the cheapest form of utility scale electricity generation technology.  This is because of the availability of potentially good financing, and the high costs of imported fuel for existing diesel generation.  If Eritrea develops its wind electricity generation capacity it also has the potential of exporting its expertise and its electricity.  In the Aseb area, Eritrea has large areas of world class wind energy sites.  Over the long term with increasing economies of scale and decreasing wind turbine costs, this area holds the promise of as much as tens of thousands of Megawatts of economical electricity generation capacity with tens of billions of dollars worth of development potential.

Solar photovoltaic (PV) production is growing at about 20-25% per year.  Eritrea already has fairly aggressive solar PV supply, installation and support programs.  Solar PV systems were used during the independence struggle, and Eritrea had about 200 kW of installed solar system capacity (perhaps 1/3 - 1/2 of systems were probably destroyed or looted by the Ethiopians during May 2000 invasion) before the recent conflict with Ethiopia.  Solar PV systems are most appropriate for high value rural uses where the value of the electricity produced is above $0.25 per kilowatt hour.  Such applications are typically rural water pumping applications, electricity supply for medical clinics or high efficiency school or community lighting.  With the advent of extremely high efficiency Light Emitting Diode (LED) lighting, it may also become feasible to provide residential lighting through solar PV systems.

Renewable energy production also reduces imports and improves Eritrea's balance of payments as long as the overall project is a feasible investment.  Each kWh produced by renewable resources within Eritrea reduces the need for imports of petroleum-based fuels and has a positive impact on Eritrea's balance of payments.  The exact size of this impact depends on the inefficiency of the generation that is being displaced, and the price of the fuel on the international market.  Currently for each megawatt hour generated by renewable resources, Eritrea saves about 250 kilograms of petroleum imports with a savings of  $50 or more on Eritrea's balance of payments/trade.

Model Results

The economic results are summarized in the following table for the 2001 - 2050 forecast period:
 

Technology	Capital Expense (millions US$)	Retail Savings (millions US$)	Trade Savings (millions US$)	Retail Return Rate	Trade Return Rate (Case 1)	Trade Return Rate (Case 2)
Wind Energy	$161	$108*	$94	6%***	1%	28%
Solar PV	$48	$50**	$6	7%	-10%	2%

* For wind energy sales, revenues are the avoided fuel costs of wholesale electricity supply (estimated to be $0.045/kWh) plus carbon mitigation revenues.
**For high value uses that are valued at $0.35/kWh.
***The return rate on net capital investment compared to fuel oil generation investments

We see from these results that the economic benefits for wind and solar energy at large scales of development are not as clear as the economic benefits of efficiency.  But both technologies can provide respectable retail return rates that can be improved if economies of scale and innovations in implementation can reduce capital investment costs or increase production significantly.  For wind energy it is likely that the cost per installed kilowatt will continue to decline.  Meanwhile for solar energy  continued investment cost improvements are also expected as are continuing improvements in the efficiency of devices connected to solar PV systems.

For both technologies, the impact on balance of trade is not very good as both technologies are largely imported.  For the balance of trade case, we examine two cases.  Case 1 is where 100% of the capital invested comes from discretionary capital that could be invested in other areas.   Case 2 is where about 80% of the capital is new capital that is raised specifically from international partners interested in renewable energy.  For Case 2, the capital flows are in some sense 80% free since they are not draining capital from other national investment projects.  In the case that the capital is "new renewable energy capital" the wind energy development has a very positive effect on balance of trade, while solar PV development does not have a positive effect unless Eritrea develops some sort of export market based on the applications of solar PV.  This means that from a balance of trade perspective most investment capital for solar PV should come from foreign sources, rather than discretionary local sources.  But when the social benefits of the solar PV systems are high (e.g. with medical clinics, water pumping, and school lighting), the social benefits outweigh the adverse impact on the balance of trade.

Wind and solar energy also hold the prospect of making a significant contribution to total national capital accumulation. We estimate the total net present value of Eritrean capital expenditures for the forecast period to be approximately $12 billion. Of this amount about 15% or about $2 billion would probably be spent in the energy sector.  And if wind and solar can obtain about 80% of their capital from new foreign sources, then they can add to the energy sector capital investment by about $160 million or 8%.   This added capital investment can help accellerate the edevelopment of Eritrea's energy sector and economy.  This is perhaps one of the more strategic contributions that renewable energy can make to Eritrea's development

Demand Curves for Efficiency and Renewable Energy Investments

A demand curve shows to what extend the decreasing price of a product translates into increasing volume of demand.  The demand curve is often plotted together with the supply curve to show the economic relationship between supply and demand.  A supply curve show how increasing price prompts suppliers to provide more volume of product supply.  Where the supply and demand curve intersects is in theory the optimum match between supply and demand.

With regards to energy sector investment and development, the Eritrean energy sector has a demand for investment capital needed for its development.  Meanwhile local private investors, foreign private investors, the government, development aid agencies and banks all supply investment capital and financing for economic development investments.  The macro economic goal of the government is to set terms and conditions for investments that promote the optimum long term economic development of the country.

For capital supply and demand, the price of capital is the interest rate or the rate of return.  Banks and investors (capital suppliers) require an interest payment or profit in return for theirr investment capital.  National economies, countries, and investment projects provide revenues that represent a rate of return for the investment capital they demand.  In any given period, as the amount of investment goes up, it gets harder and harder to generate new revenues with each added investment dollar, and the rate of return decreases with increasing investment levels.  The optimum investment level is one that provides the desired rate of return given the goals and risks of the project.

Figure 3: Demand curves for capital investment in efficiency and renewable energy.  The upper blue curve is the return rate when local project revenues are considered, the lower red curve is the return rate from a trade balance perspective.

Figure 3 shows the capital investment demand curves for energy efficiency and renewables from both local project and trade balance perspectives.   From a project perspective, biomass efficiency is an extremely feasible project because of the tremendous non-monetary benefits that we included as project returns.  Next, both petroleum and electricity sector efficiency are very feasible investments.  Efficiency investment combined can absorb nearly 6 million dollars per year in capital investment and provide good returns from both trade balance and project perspectives.

Beyond about the $7 million per year level, one needs to be a bit more careful about the projects and investments to make sure they make a good contribution to Eritrean development.  If the projects can be leveraged with low-cost foreign financing, or if investment costs can be substantially reduced, then another $3 million to $13 million in annual investment may be feasible.  

We therefore conclude that the target investment levels for efficiency and renewable energy over the next period should be in the range of  $6 million to $20 million per year with the primary emphasis for the first $5 million/year on biomass, petroleum and electrical efficiency in that order.  We also believe that with external financing cooperation and aid, (which compensates Eritrea some of the global environmental benefits of renewable energy) another $3 million to $12 million per year may be invested in wind and solar energy development.  Wind enegy development with sufficient finance leverage will contribute to improving Eritrea's balance of trade.  Meanwhile solar energy development should focus on very high value applications with significant social benefits, because the purchase of solar systems adversely impacts Eritrea's trade balance compared to other energy supply options.
 

Conclusions and Recommendations

First given the general rule of thumb that about 10% of investment expenses should be in planning, development, and engineering, we can set rational target levels of funding for efficiency and renewable energy technical research and development. For efficiency development and technical support reasonable funding level would be approximately $600,000 per year (for all subsectors).   Meanwhile for renewable energy research and development it should probably be about $500,000 per year.  This in many ways defines the size of the research development and consulting markets for energy efficiency and renewable energy development in Eritrea.

Within the approximate resource constraints of this planning, development, and regulatory activity, there are several things that the Eritrean government and private businesses can do to facilitate investment in efficiency and renewable energy:

1. Aggressively pursue biomass efficiency projects (because of the very high return on investment...note this activity is already underway)
2. Set up or assign an energy efficiency policy and regulation office or body.
3. Facilitate training of up to 20 energy efficiency and 20 renewable energy professional and technical staff so that Eritrea is capable of facilitating energy sector investments in efficiency and renewable energy.
4. Build institutions in the Department of Energy or the Department of Environment that can certify and keep accounts of Eritrea's carbon emissions reduction credits (valued potentially at $3 million to $6 million per year).
5. Facilitate the formation of local business that can consult, provide services, and distribute products for energy efficiency and renewable energy.
6. Develop selected projects in public/private partnerships.
7. Seek international investment partners who will provide good financing terms for renewable energy investments.
8. Provide ample credit and support services for efficiency investments (and selected renewable energy investments).
9. Continuously monitor, evaluate, support, and gather information on efficiency and renewable energy opportunities.

REFERENCES

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Jennie Street, "Korea takes the lead," Africa Business, April 1998,
URL: http://ds.dial.pipex.com/icpubs/ab/apr98/absr0403.htm

International Monetary Fund, Eritrea: Statistical Appendix, Series: IMF Country Report No.00/55,  May 11, 2000, ISCREA0055, 59 pp, URL: http://www.imf.org/external/pubs/ft/scr/2000/cr0055.pdf

Lahmeyer International, Strengthening the Department of Energy, Final Report, April 1997.

Prototype Carbon Fund, PCF-IN #5: Price Formation in PCF Emissions Reductions Purchases, World Bank, Prototype Carbon Implementation Note #5, December 6, 2000.
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Rosen, Karen, An Assessment of the Potential for Utility-Scale Wind Power Generation in Eritrea, Masters Thesis in Environmental Studies, San Jose State University, San Jose, CA USA, August 1998.