The National Electric Grid and the Future of the Cuban Economy (revisited)

Introductory Note to the republication of “The National Electric Grid and the Future of the Cuban Economy”

On Friday, October 18, 2024, there was a total outage of Cuba's National Electric Power System (SEN). By Tuesday, October 22, the system had still not fully recovered. By any standard, this represents a dramatic deterioration of the island's already precarious energy conditions. It also represents a major setback for the economy, the well-being of Cubans and government operations. From one vantage point, this failure does not come as much of a surprise. The progressive deterioration of the SEN began much earlier, and little has been done to address the root causes that have led it to its current state.

Energy infrastructures are complex and costly systems, whose operation and maintenance require long-term strategies and considerable resources. It is paradoxical that, in a model of “centralized planning” and with a government that is not subject to traditional electoral political cycles, Cuban authorities have not developed a strategy to sustain this critical infrastructure. Given the need for a reliable energy supply, virtually all other “priorities” need to take a back seat. Without energy, there is no country, no future.

However, a look at how resources have been invested over the last decade and a half, demonstrates a steep gap between the sums allocated to the hotel industry and those allocated to sectors such as energy, agriculture or manufacturing. It is illogical to continue to commit resources to the hotel industry while ignoring national priorities. Infrastructure is the foundation of any economy, and its development must come first to prevent it from slowing down or, as in this case, paralyzing productive and social activity. Fuel shortages are the other side of the same coin. Cuba has to abandon its reliance on special agreements with like-minded countries to supply its energy. On the contrary, it has to build a competitive economy that generates sufficient resources to pay for its imports.

Cuba’s almost total lack of access to external resources is the result of a model that is perceived by creditors and investors as stagnant and impoverishing. It is well known that Cuba did not take advantage of the opportunity it once had to join a large development bank in Latin America.  It was the island that voluntarily withdrew from the World Bank in 1964 and from the International Monetary Fund in1960, protesting U.S. control over both.

Although the U.S. sanctions regime affects the productivity of the Cuban economy and complicates its international financial relations, Cuba has important allies. However, they are deterred by the Cuban government's inability to abandon an inefficient economic model and implement market reforms that create a framework of incentives to attract investment and stimulate growth. 

The article below was written approximately two years ago.  Our straightforward assessment then was that a breakdown of the electric grid was likely to occur.

The key messages are clear:

1. Cuba should aim to build a diversified energy system based on modern and efficient technologies, with a high penetration of renewable energies, prioritizing solar and biomass.

2. The recapitalization of the SEN and the expansion of renewable energy sources require multi-million dollar investments (and a lot of time), and will need to be financed mainly through foreign credits and investments. At the moment, neither the State nor the citizens of Cuba have the resources to pay for this transformation.

Only a growing productive economy can generate the surpluses needed to finance this transformation; and that depends on pendant economic reform. Under the current agricultural model, there will be no recovery of the sugar industry. The economic crisis is also extinguishing the sugar industry.

In the very short term, only emergency solutions can be implemented, but those cannot prevent the next energy crisis. Hopefully, this energy disaster will be an inflexion point that spurs the necessary changes.

Original text below

The National Electric System (SEN) faces far-reaching technical challenges that threaten the economic and social development of Cuba.  After more than forty years of operation without capital maintenance, the basic thermoelectric generation infrastructure, as well as its distribution capacity, have collapsed.

Electricity is a central element of development, necessary to attract investments, permit technological innovations and foment the emergence of new industries.  These are the engines of job creation; the quality of most public services such as health and education depend on it.

Currently, the global power generation sector is undergoing a massive transformation, as a result of increasing pressure to reduce carbon emissions and rapid and profound technological developments in renewable energy.

Cuba lacks a detailed strategic roadmap towards a comprehensive national energy policy that addresses these challenges. Since the government announced in 2014 a strategy to increase the share of renewable sources in electricity generation, that portion has hovered around 5% (4.8% in 2021). In 2021, the authorities increased that target to 37% in 2030 (previously it was 24%), despite the slow progress achieved in the first eight years of the period (2014-2030).

A coherent policy and regulatory framework are essential for Cuba to facilitate an energy transition that does not disrupt energy supply, nor limits fuel supply to preferential political deals, incorporates short-term price subsidy programs, or employs inefficient technologies. Likewise, due to the current monopolistic model of infrastructure in the Cuban economy and society, and because of the enormous amounts of resources necessary to turn the current situation around and achieve some progress, energy policy cannot be implemented disconnected from other more general changes in the economic production model.  Those changes are critical to progress in energy production and make it viable in the long term.

Background

Blackouts were one of the most prevalent and feared manifestations of the serious economic crisis that devastated the Island in the early 1990s. Again, in the summer of 2004, the Island went through episodes of blackouts as a result of deficits in generation. From that more recent crisis arose the so-called Energy Revolution and the government changed the leadership of the then Ministry of Basic Industry, responsible for the sector.

With few traditional sources of its own, Cuba has always been dependent on imported energy. The replacement of the United States by the Soviet Union as the main trading partner and political ally was particularly visible in the change in supply of hydrocarbons. The distortions inherent in trade with the socialist countries of the time had the paradoxical result of recreating an economic structure with a high energy density, despite Cuba having modest per capita income levels and being a net importer of energy.

Almost a decade later, the relationship with Venezuela gave way to a scenario of guaranteed access to hydrocarbons under preferential conditions. Investments were made that allowed the resumption of operations at the Cienfuegos Refinery, while the export of refined products became an appreciable source of external income for several years.

Since 1990, electricity generation supply has grown, but very slowly, at 1.1% per year, representing a third of the rate of growth worldwide. Where a fundamental change is evident is in the destination of that production. In Cuba, the residential sector absorbs 60% of the electricity produced, compared to 42% on average in the Caribbean. Between 2000 and 2020, the residential sector in Cuba more than doubled its total consumption.

In order to understand this, there are several factors to consider.

• First, the figures for residential use actually include consumption by the private sector.  Despite being a production sector, private sector activity was not counted separately by the government until 2020. Self-employment (the predominant appellation or the private sector) has expanded rapidly since 2010 and employed more than 600,000 workers in 2019. Almost all of this activity was subsumed in the data for residential consumption. In 2021, reported energy consumption by the private sector only represented 3.6% of the national total.

• Second, starting in 2005, the so-called Energy Revolution modified the structure of household energy consumption, expanding the weight given to electricity, especially that used for cooking food. ^[i].  Beginning in 2016 it became evident that the Island could not continue to count on abundant supplies of oil from Venezuela, as it had enjoyed until then. The Cuban government was forced to begin rationing electric consumption by state enterprises in order to minimize the impact on the residential sector.

• Finally, the data suggest that the dynamics of the Gross Domestic Product (GDP) does not reflect certain sources of household income in foreign currency. In other words, certain family income streams do not fully depend on domestic economic activity. In particular, alternate sources of revenue, such as remittances from abroad, income from private professional activity carried out abroad, and revenue from the informal market are not reflected in the data.^[ii]  In a scenario like the one described above, it is clear that the revenues that could be generated by the national electric utility, Union Eléctrica de Cuba (UEC), will not be sufficient to re-capitalize the industry. Household income in foreign currency does not flow directly to UEC, but, rather, basically reaches the state through retail trade, hotels, communications and transportation. Theoretically, a centralized system like the Cuban one would be very effective in matching sources and destinations of energy, allowing the balanced functioning of the economy and society.  Nonetheless, the current energy situation in Cuba shows that this has not been the case.

Thermoelectric Generation

A triggering factor for the current crisis is the sustained reduction in fuel imports from Venezuela. In 2016, PDVSA  (the Venezuelan national oil company) withdrew from its joint operation of the Cienfuegos refinery. Venezuelan oil imports went from an average of 99,000 barrels per day in 2013, to around 57,000 in 2021. Various press reports suggest additional reductions occurred during 2022.

Electric power has become the Achilles’ heel of Cuba’s energy sector and economy, as its oil-based distribution and thermoelectric generation collapsed due to age and lack of scheduled and capital maintenance. Recent information from UNE indicates that less than 40% of the sector's total oil thermoelectric generation capacity is operational, resulting in prolonged blackouts of eight to 12 hours throughout the country. The distributed generation strategy (Grupos Electrogenos), implemented during the 2006 “Energy Revolution”, has shown its limitations. According to UNE reports, 59% of its nominal installed capacity is out of service as a result of equipment failures and a shortage of diesel fuel.

In December 2022, with the incorporation of two new mobile floating Turkish power plants in Havana Bay, ^[iii] along with a 17% reduction in average demand, the frequency and duration of power outages has been reduced.

Natural Gas

The substitution of liquefied natural gas (LNG) for the highly polluting oil with a high sulfur content, as a fuel in base-load electric generation, has a number of economic, environmental and social benefits. LNG is an energy source of fossil origin that offers multiple advantages: competitive pricing, secure, available supply, and lower pollution generation than oil or coal.

Natural gas, like any other fossil fuel, produces CO2; however, its emissions are 40-50% lower than coal and 25-30% lower than fuel oil, making it the cleanest of fossil fuels. Natural gas has a sulfur content of less than 10ppm (parts per million), so sulfur dioxide emissions, the main cause of acid rain, are 2,500 times lower than those emitted by fuel oil. Cuba should consider increasing the share of LNG electric power generation for its power generation.

Renewables: Sugarcane Agroindustry

The recapitalization of the sugarcane agro-industry deserves important attention within Cuba's future energy policy. This would bring considerable economic benefits: new capital investment, job creation, support for the balance of payments by reducing demand for imported oil, and create new sources of export revenue.

Electricity generation through biomass is not an isolated industrial transformation process; without sugar cane there is no bagasse, without bagasse there is no electricity. In 1990 Cuba had, in sugarcane products, the equivalent of three million tons of crude (almost 60,000 barrels per day). In 2021 it has barely a quarter of that figure. One of the difficulties that the bioelectric plant near the Ciro Redondo power plant in Ciego de Ávila has had in attracting investment is precisely the shortage of sugarcane biomass.

From the planting and cultivation of sugarcane to the production of its main derivatives: sucrose, molasses, alcohols, fuel ethanol and bagasse, all affect the economic optimization of agroindustry. The viability of this biomass option depends on a far-reaching reconfiguration of agricultural and rural policies.

Missed Opportunities

Cuba has had several projects to increase electricity generation capacity that have not been executed successfully due to a number of factors such as lack of management skills, technical challenges, minimal financing, and the complex bureaucracy of the state business model.

In 2014, the UNE and the Russian semi state-owned Inter Rao committed to a project of 800MW - $1,360mm US dollars - in new thermal generation capacity in the Mariel Development Zone and Habana del Este by the first quarter of 2016.

In 2013, the construction of a wind farm with a generating capacity of 50MW was announced in La Herradura, in the province of Las Tunas. China extended credit and technology for the installation of 34 turbines for a total of 51MW manufactured by China's Goldwind. The project was expected to be operational by early 2018.

In 2012, the company Biopower was created, as a joint venture of the ZERUS company and the British Havana Energy Ltd. to build a 62MW biomass plant at a cost of $186MM US dollars adjacent to the Ciro Redondo sugar mill. The construction of the plant began in 2017 thanks to the financing and technical support of the Chinese company Shanghai Electric, finally entering the SEN energy grid in December 2021. Today it is operating intermittently due to lack of biomass.

Who pays the bill?

It is important to put on the table the insurmountable challenge facing the Cuban government, in terms of time and costs, if we recognize that the only solution to the problem is the recapitalization of the National Electric System (SEN).

The recapitalization of the current installed capacity of 6,600 MW SEN would take five to ten years to execute at a ballpark estimate of between $8-10,000 million dollars. This example assumes a substantial transformation of the current generation structure in alignment with the estimated demand.

For assumptions on the estimates of capital costs for electric generating plants, we consulted the data published by the US Energy Information Administration (EIA) in March 2022. https://www.eia.gov/outlooks/aeo/assumptions/pdf/table_8.2.pdf

It is important to recognize that projects must be profitable for investors, whether they are public or private. A fundamental factor affecting the profitability of power plants is the inherently complex total cost of construction.

The World Bank defines a Public Private Partnership (PPP) as a long-term contract between a private party and a public entity, to provide a public asset or service, in which the private party assumes substantial risk and the responsibility of management and remuneration is linked to performance.

Therefore, Cuba should consider, within a decentralized economic model, promoting the use of Public-Private Partnerships (Design-Build-Operate-Maintain-Finance) that would attract private and multilateral capital financing for public infrastructure projects, freeing the government to use its limited revenues for education and health care, while maintaining regulatory control over public infrastructure projects.

Cuba, as a state, as well as its citizens (consumers), do not have the economic resources to pay for the cost of the recapitalization of the SEN. Cuba does not have an economic model that can generate the resources to pay the debts necessary for the recapitalization of the electricity sector - much less its current debts in other sectors of the Cuban economy. Nor does it have an economic model that allows citizens to create wealth, contributing their fair share of taxes to the state, and leaving them disposable income to pay the cost of a sustainable, safe, and affordable electrical service.

Cuba will require a combination of state subsidies, progressive tariffs based on consumption, more flexible legislation to attract foreign investors, and possibly offer its own resources and assets to finance the energy transition. Cuba already uses a progressive rate, but still subsidizes 89% of residential customers. Their ability to pay is directly related to their income. As long as the Cuban economy remains stagnant, it will be difficult to make the changes that will guarantee the required investments.

But unfortunately, we don't have the answer to the question: Who pays?

Conclusions

There is no short-term solution to Cuba's energy challenges. The country does not have the domestic oil and natural gas resources necessary to meet its own needs and will have to continue to rely on imports of petroleum liquids and liquefied natural gas to fuel its future economic growth.

The country's electricity generation infrastructure is antiquated and with little chance of repair.  It will take years and billions of dollars to rebuild its baseload and distribute thermoelectric generation capacity to achieve its goal of 37% renewables within its power sector energy matrix. Renewable energy sources are at the center of the energy transition agenda around the world, but it is a mistake to equate them with cheap energy. For example, a high proportion of wind and solar power in the electrical matrix requires energy storage. These storage systems are expensive.

The example of a small Latin American country helps to illustrate the current challenges. Uruguay achieved a remarkable transformation of its energy matrix, offering investors attractive prices with long-term guarantees (20 years). The electric operator pays almost eight cents per kilowatt to wind generators, which have been the fastest growing energy source in the last decade. The total investment to date exceeds seven billion dollars in a country of 3.5 million inhabitants. Energy is abundant in Uruguay, but it is still expensive.

The average Uruguayan household paid 21 cents per kilowatt in 2021, as compared to 14 cents in the United States. If we consider the difference in per capita income between the two countries, electricity is almost four times more expensive in Uruguay. This scheme was possible as a result of the combination of substantial regulatory changes along with a growing economy – one with a GDP per capita much higher than that of Cuba (US$ 21,269 compared to US$ 7,879 in 2021^[iv] .

Cuba urgently needs two things that it does not have: time and money.

There are a number of issues that Cuba must address first, if it is to attract much-needed foreign direct investment and support from multilateral financial institutions:

• Cuba must reevaluate its centralized economic model. A prosperous economy is in a better position to face the costs associated with the energy transition that the Island is undergoing, if it aspires to economic and social viability in the 21st century.

• Cuba and the United States must find a political solution that addresses the restrictions of the Cuban Democracy Act, codified in 1992, and the Helms-Burton Act, of 1996, which limits US trade and investment in Cuba.

• The population of Cuba must reach a standard of living necessary to pay the unsubsidized cost of clean and sustainable energy in accordance with an acceptable rate of return for the investor.

Cuba faces a long and arduous road in order to achieve a comprehensive national energy policy that produces safe, clean, efficient, reliable, sustainable and affordable energy.

[i] While recognizing its benefits, the particular current conditions in Cuba is hard on families.  These include cooking equipment distributed massively of low quality and durability with the poor after-sales service, including shortages of spare parts, together with a dependence on an electric system that is vulnerable to blackouts.

[ii] For example, the domestic retail market supplied by individuals purchases abroad (shopping tourism).

[iii] The nominal capacity of these units is 245 MW, which does not have to coincide exactly with the contracted capacity.

[iv] According to estimates by the United Nations Development Programme (UNDP) in the Human Development Report 2021- 2022.

Jorge R. Piñon began his thirty-two-year career in the energy sector when he joined Shell Oil Company’s supply and transportation organization. He served as president of Amoco Oil de México and president of Amoco Oil Latin America, based in Mexico City. After the merger between Amoco and BP, Mr. Piñon was transferred to Madrid, Spain, to manage BP Europe’s western Mediterranean petroleum supply and logistics operations.

Prior to joining The University of Texas at Austin as Director of The Center for International Energy and Environmental Policy’s Latin America and Caribbean Energy and Environmental Program he conducted research and country energy risk assessments as a Visiting Energy Fellow at the University of Miami’s Center for Hemispheric Policy, Brookings Institution and Florida International University’s Latin American and Caribbean Center.

Today he is an Energy Fellow at The University of Texas at Austin’s Energy Institute where he focuses in developing and maintaining a network of regional stakeholders that would likely affect UT Austin’s faculty, researchers, staff and students Latin America and Caribbean research programs and initiatives.

Mr. Piñon has testified on regional energy issues before committees of the U.S. Senate and U.S. House of Representatives. He holds a degree in Economics and a certificate in Latin American Studies from the University of Florida, from where he received the Center for Latin American Studies 2019 Lifetime Achievement Alumni Award.