Tuesday, 12 July 2011

A first Microeconomic analysis of the disaster in the Naval Base and Vasiliko Power station.

*****14/07/2010 update: substantial aid in terms of electricity expected from UN force in Lebanon (Germany) and Greece. Expected to alleviate partially the effects below, especially if they pay their costs of production.

The economic effects of the apparent negligent homicide in the “E. Florakis” naval bases are immediate and far reaching. I will concentrate on the microeconomic consequences here, but i am hoping to expose the macroeconomic effects as well as the criminal, political and psychological damage in further articles.

Economically speaking the effects where the tragic loss of life (which needs to be compensated as their death was apparent homicide), the loss of skilled workers and the damage to our electricity network.

The Vasiliko power station is gone. This event is the largest negative shock to our economy since the Cyprus invasion of 1974. One could ask how is it possible that in a country living under the threat of a possible war, our capacity to generate electricity was centered on just one source. Although the plant was 60% of our capacity, it must be realized that it was by far the cheapest source of energy on the island, and hence its 60% was almost always in use. The graph below (from the transmission system operator) indicates the seriousness of its loss.



The ability to produce electricity was about to receive a massive boost from the unused new power unit at Vasiliko, comfortably being capable in boosting production to above 900 MW hours, the average peak demand in the summer. The destruction of the power station (and the new and unused power unit) meant that we are suddenly not in any position to satisfy the projected summer demand of 900MW, since our maximum capacity has been cut way below the peak demand for electricity. Even if the projected capacity rises over time, we are doomed to still face power cuts and disruptions since no electricity grid can operate without some capacity going offline for repairs and maintenance.

So despite the government’s encouraging announcements is it very clear that we will be in this situation for at least a year: barring building a new power station in record time, the measures suggested by the government can only provide an additional 10/100 MW each. Floating electricity plants can provide more than 200MW which would ease the situation, but such big electricity systems can really operate in very calm waters (i.e. rivers) and in areas where the electricity infrastructure has been adapted to its use; we will need to construct the capability to house such a unit, which might take 6 months. They are also usually very expensive to run and maintain, as the experience of Pakistan shows.

The dire situation is confirmed when one looks at the electricity consumption of this week last year, shown below:



Assuming the fact that we can operate at full (750MW) operating capacity at all times, we could not cover the electricity needs of last year needs during the weekdays, as demand in peal time is way above our cut off of 750MW.

However the cost of this explosion does not just affect in terms of rebuilding, compensating and repairing. The dynamic effects on companies will ensure a return to recession, especially if you factor in the effects of the electricity crisis is having in Cypriot companies. The electricity shortage causes three devastating blows to our economy: Reliability, Capability and Cost.

The lack of Reliability in electricity provision provides a great drag to the economy. Already power cuts are taking place and sadly it seems that since our electricity system is operating in full capacity the authorities have not been able to announce when and where such cuts should occur. As a result business are already suffering from lost labour time, repairing software and hardware issues relating to cuts, and an ever greater need for technical support, all in a period where the focus has been to cut costs and thus remain competitive to other European companies, who can operate freely in the EU market without having such reliability constraints.

The lack of reliability makes the desire for the imposition of Flexible working hours immediately. Government offices especially should move to working hours that go around the peak time, and thus reducing the load on the network. There should be an immediate agreement with the unions to adopt the model of the Cyprus Central Bank, where staff is in several shifts with varying starting times, from 8:00 to 12:30 and various leaving times from 5:00 to 8:00. This will spread electricity demand enough to ensure we stay below our maximum capacity and this will aid in reliability. The electricity authority should also release a schedule of cuts as soon as possible, and emergency legislation should be put in place to allow companies to schedule working time around these cuts without fear of union action for as long as the shortage in electrical capability is an issue.

The second is electrical capability. This in an issue usually faced by Less Developed Countries, whereby several innovative ideas and machines can fail due to the fact that electricity is rationed. Electricity is what we call a “general purpose” technology: it allows for other machines and people to make their jobs more effectively. Any restriction in our ability to use electricity also restricts our ability to use other machines, which are constructed for countries where electricity is not a rationed good. As a result the rationing of electricity lead to a slower dissemination of productive technology in the economy.

A good example of our diminished capability and the additional cost to society is the traffic chaos that the electricity cuts have been causing, since traffic lights switch off, causing accidents and delays, and needing an ever greater number of traffic officers diverted from more important duties.

The third and most pressing issue is cost of the current electricity provision. Power stations have massive economies of scale; this means that the cost per unit of electricity produced gets cheaper and cheaper the bigger the power station. Vasiliko was the biggest (and most modern) power station we had in Cyprus, and thus it produced the cheapest electricity per unit. The remaining power stations were effectively backups to Vassiliko: their cost per unit of electricity was much higher, and their capacity was effectively only used when the power needs were higher than Vasiliko’s capacity to cope. In addition running such factories at 100% of their capacity dramatically raise costs, as staffing cost rise and the necessity to expedite spare as well as putting less efficient generating machines online.

So the raising of the cost of production leads to the big issue that all politicians avoided: A new increase in the electricity bill of Cypriots is inevitable, as the Electricity Authority, who has also posted large losses and has already substantially increased the electricity bills of consumers by 30% in April.
Let us be clear: this is not an additional cost to repair (or rebuild) the Vasiliko power station. This is additional cost that we have to pay for the current electricity we receive from other sources, now that the cheapest source of electricity has been destroyed.

This is the most terrible news for our economy. When companies are faced with increased cost of production, the reduce the quantity the produce at any price. If the company was willing to produce 1,000 shampoo bottles for €2 euro, it will now have to produce less if the market price remain the same. The result is more companies on the verge of bankruptcy and more unemployed workers, just as the economy is struggling to get back on track after the recession.

This accident has singlehandedly led us back into a recession, with very serious consequences both for our level of unemployment, our society and our credit rating. Quick, decisive action is needed. In a crisis a government that leads with brevity, rapidity and open to radical solutions can act as a positive catalyst. Sadly, the 3 years in power show that this government lacks, the strength, will and ability to do anything drastic.

2 comments:

Protesilaos Stavrou said...

The blow is indeed immense and the economy will have a tough time getting out of this situation, that maladministration has brought us into.
You correctly point out that it is not acceptable for a country that is threatened by war to concentrate its power production on a single unit. This is way too irresponsible. Moreover it is ridiculous that the country does not have alternative energy solutions to deal with crises such as this.
I find it insane and obscene that an island so much gifted with renewable energy sources, has not even invested in creating backup renewable energy plants for such dire moments.
Open mind, courage and swift actions are now needed to adopt to the newly-shaped events. However as you correctly point out in your concluding remark, the current government does not have any of these.

Finally I would like to add food for thought in this excellent analysis, by asking what will be the other side of the catastrophe, considering that many countries have come to the support of Cyprus. Can we expect short-term increase in GDP if foreign money flows into Cyprus in one way or another?

Alexander Apostolides said...

It is true that construction will lead to an increase in GDP. Hence that is why i think that GDP is a terrible way to measure destruction from natural or man made disasters. I prefer to see what happens to the Capital to labour ratio. For me that is a much better indicator of capability of growth in the future, and a much better understanding of the long run impact of such a disaster.