THE YALE SCHOOL OF MANAGEMENT

An Analysis of Foreign Direct Investment

(FDI) and Energy Generation in
Costa Rica’s Wind Energy Sector:
Opportunities and Challenges

Mian M. Hussain
7/26/2010
Acknowledgements

It would not be untrue to say that I was somewhat daunted by the task at hand when I landed in Juan
Santamaría Airport at the end of May. I recognized that the only way I would succeed in completing this
project within the short timeframe available was through the support of those intimately familiar with Costa
Rica and its intricacies. Over the course of my time here, I have had the privilege of meeting and working with
young (and some not so young!) leaders from all walks of life, all of whom have helped to make the
experience a very memorable one.

I would like to use this page as a podium to express my deepest gratitude to all of these individuals. The
number of people I had the privilege of meeting makes it difficult to mention each one but I would like to
take a few words to thank Roberto Jiménez for providing this truly wonderful opportunity and to Ricardo
Zúñiga and Raúl Guevara for being gracious enough to provide an office from where I could complete this
work. I would also like to thank all of the members of the Batalla Abogados team for being such wonderful
hosts. Of particular note are Ignacio “Nachito” Guzmán and Oscar “Osquitar” Sandoval who taught me the
importance of Spanish diminutives. I shall henceforth be known as “Mianito”.

Many of the insights gained through this project came from individuals with an intimate knowledge of energy
and environmental issues in Costa Rica. These include Pablo Jenkins (Clean Technologies Cluster), Rafael
Monge (Clean Technologies Cluster), Saúl Kierszenson (Clean Technologies Cluster), Esteban Bermúdez
(Clean Technologies Cluster), Felipe Castro (Clean Technologies Cluster), Sofía Zúñiga (Batalla Abogados),
Albán Sánchez (Procomer), Carola Medina (Procomer), Catherine Reuben (CINDE), Jay Gallegos
(MesoAmerica), Lawrence Pratt (INCAE), Arellys Cedeño (La Republica), Timothy Lattimer (U.S. Embassy),
Maricela Muñoz (U.S. Embassy), Daira Gómez (CEGESTI), Sylvia Aguilar (CEGESTI), Mauricio Castro
(Fundecooperation), Marianella Feoli (Fundecooperation), Kate Cruse (U.K. Embassy), and Astrid Gomez (U.K.
Embassy). Without your support and guidance, this work would not have been possible – thank you!

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Executive Summary

An analysis of the wind energy industry in Costa Rica was conducted in order to determine opportunities for
Foreign Direct Investment (FDI) as it pertains to the manufacturing of wind turbine components. A secondary
analysis – focused on the wind energy generation market – was also conducted in order to highlight the
challenges of meeting growing demand as well as the opportunities for energy exportation through Central
America.

It was determined that Costa Rica has the potential to build power electronics and transformers for wind
turbines. These compromise roughly 5% and 4% of the total cost of the turbine which is estimated to be €1.2
million per MW. Poor transportation infrastructure in Costa Rica was cited as a factor which added to the
challenge of manufacturing turbine components, however. Additionally, it was found that the transportation
costs associated with larger components i.e. blades made them less attractive economically.

The wind generation market, when viewed from a purely economic standpoint, was discovered to offer wide
ranging opportunities. The rise in electricity demand both within Costa Rica and elsewhere in Central America
were cited as key factors driving growth in this market. Additionally, the seasonal offset of wind and rainfall
was noted to be a key feature in favour of wind power’s candidacy in Costa Rica’s future energy portfolio.
Furthermore, the facilitation of energy transfer through Central America via SEIPAC was cited as a factor that
could facilitate the implementation of energy as a regional export.

The biggest challenges to the implementation of business models based on the sale of wind derived energy,
both domestically and through Central America, were determined to come from the misalignment of stated
public policies and actual economic policies. In particular, it was noted that the current pricing schemes
offered by the government owned organization was insufficient to drive investment from the private sector.
The growing demand within the country and current budget deficit also raises questions about whether the
government will be able to meet the future demands of the country without support from the private sector.

The key recommendations as a result of this work are two-fold. With regards to manufacturing, Costa Rica
should work directly with turbine manufacturers in order to assess the possible implementation of power
electronics and transformers manufacturing facilities. With regards to wind energy generation, the
government should take steps to ensure that wind energy forms a larger part of Costa Rica’s future energy
portfolio. In addition, it should reassess its economic policies with the aim of creating an economic
environment conducive to attracting private sector investment.

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Background and Motivation

The project that is the subject of this paper was conducted on behalf of the Clean Technologies Cluster of
Costa Rica. This not-for-profit organization is a coalition of organizations and individuals in Costa Rica’s clean
technology sector whose objective is to help spur economic growth in Costa Rica, one of Latin America’s
fasting growing economies, while keeping sight of the environmental impact that invariably accompanies
economic growth. The Clean Technologies Cluster does so by creating “green-collar” jobs through the
following three-way strategy:

(1) Attracting Foreign Direct Investment (FDI) in the clean energy sector
(2) Advocating for environmentally responsible policies at the national level
(3) Assisting environmental entrepreneurs launch new businesses

The focus at the onset of this project was the first of these three strategy components – attracting FDI in the
clean energy sector. The study initially aimed to analyze various types of renewable energy sources including
but not limited to biofuel, solar energy, wind energy, and energy efficiency. As the project evolved however,
it became clear that there are enormous challenges in competitively producing biofuel. Limited time and
resources therefore led us to narrow our focus on wind energy which we believe holds enormous potential as
a renewable energy source within Costa Rica.

An equally important item that we learned over the course of the project was that some of the largest
obstacles facing the future of clean energy production and distribution within Costa Rica were not technical
but related to the misalignment of stated public policies pertaining to renewable energy and actual economic
policies and incentives. In light of this finding, this paper aims to address not only opportunities related to FDI
in energy equipment manufacturing but also to highlight some of the challenges to economic growth
stemming from current economic policies. The final product of this work thus not only addresses the first of
three objectives outlined by the Clean Technologies Cluster but also highlights some of the challenges in
meeting the second objective.

Attracting Foreign Direct Investment

The economic impact of attracting FDI can be divided into the explicit and implicit components. The impact
on the Gross Domestic Product (both net and per capita) is clear; by bringing raw materials to build
components which will then be exported, companies add value to the Costa Rican economy. An example of
this can be found as recently as 1996 when Intel announced it would invest $300 million1 in a chip
manufacturing plant outside of San José, Costa Rica’s capital. At the time of this paper, Intel accounted for
20% of Costa Rica’s exports and nearly 5% of its GDP2.

The impact on the national economy of a given industry is not limited to businesses that are directly involved
in the production of goods and services in that industry, however. As an example, one may consider
agriculture in Costa Rica; companies directly selling agricultural goods, both domestically and internationally,
account for 10% of GDP3. But an examination of the economic impact of indirect players such as those in the
agricultural supply chain i.e. transporters, distributers, etc., reveals that the impact of agriculture is much
higher: 30% of GDP.

In a similar vein, the impact of foreign investment on the economy is not limited to the direct contribution of
goods or services produced. Both job creation in the manufacturing sector and technology transfer are often
cited outcomes of FDI. The impact of the latter is particularly worth considering given that the building of
competency in manufacturing clean energy machinery can be applied to other industries in the form of
technology transfer. Indeed, a number of interviewees in both the private and public sectors cited Intel as

4
one of the factors driving the Costa Rican workforce’s growing technical competency in the manufacturing of
electrical equipment.

Finally, the growth of Costa Rica’s global profile as a destination for FDI, whether in the clean energy market
or otherwise, is another outcome of this endeavour. One of Costa Rica’s greatest assets of and also one of
the hardest to quantify is its reputation as a country actively combating climate change. It is our hope that
this work will encourage economic and public policies which will further strengthen Costa Rica’s profile in this
regard.

Reassessing Energy Policies

While not an initial objective of this study, an analysis of public policy pertaining to wind energy production
and its resultant economic impact were deemed vital and hence are included in this paper. The motivation to
include this subject matter came from the recognition that the exportation of wind derived energy within
Central America could add tremendous value to the Costa Rican economy.

On a related note, we learned that while the current energy needs of Costa Rica were being met through
hydroelectric energy, there were questions surrounding whether future needs would be met given the rise in
energy demand that accompanies economic growth. To this end, economic policies that did not take into
consideration future demand could significantly hamper economic growth. It is our hope that by highlighting
some of the challenges that Costa Rica will face, we will provide an impetus to Costa Rican leaders to devise
and implement a set of economic and public policies that will effectively address these issues.

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Project Overview

In line with the first objective of the Clean Technologies Cluster of Costa Rica – attracting FDI in the clean
energy sector – the initial aim of this study was to systematically analyze various clean energy production
technologies in the context of their suitability to Costa Rica. In devising a solution, we bore in mind that the
answer to this question would be two-way; we would not only have to determine which industries were best
suited to Costa Rica based on the requirements needed to make them successful but we also had to focus our
attention on Costa Rica’s strengths and limitations. A cluster for clean technologies would only be sustainable
and competitive in the long term if both of these requirements were met.

We initially aimed to analyze the potential of three types of clean energy – biofuel, solar, and wind – in Costa
Rica. However, the final version focuses on the suitability of wind energy. This is for three reasons. First, it
became very clear early on during the study that in the context of FDI and export driven business models,
Costa Rica would not be competitive as a destination for biofuel production as this type of energy production
requires large areas of inexpensive, fertile land and an inexpensive, unskilled labour force4. Vis-a-vis countries
like Brazil, neither of these factors exists in the right quantity needed to reach the economies of scale
associated with large scale biofuel production.

Secondly, we felt that it was necessary to author a paper that rigorously analyzed the potential of clean
energy through interviews with individuals from private and public sectors, primary sources of analytical
data, and secondary sources such as similar studies. Such an endeavour required a considerable analysis of
information and ultimately could not be completed within the limited timeframe available. We therefore
decided to analyze the energy source which was the most promising from both the supply and demand sides
of the equation: wind.

Finally, a number of discoveries led us to recognize that some of the greatest challenges in the
implementation of clean energy solutions in Costa Rica lied not in a lack of resources – material, human, or
natural – but rather inconsistencies between stated public goals and economic policy. Of particular concern
was the pricing policy and economic stipulations put in place by the Costa Rican government which we felt
were not conducive to growth. An assessment of wind energy in Costa Rica would be incomplete if it failed to
highlight this problem and provide recommendations to the Clean Tech Cluster aimed at addressing this
issue.

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Market Definition

Size, Growth, and Alignment

An initial assumption upon which we based this study was that the most effective way in which we could
positively impact the Costa Rican economy would be through exports. As a country of fewer than 5 million,
Costa Rica is a fairly small market and not one that would attract significant investment. The government
owned monopoly in the energy market (Costa Rican law does not allow private companies to directly sell
energy within the country) further adds to the challenge of finding suitable buyers for manufacturing
renewable energy generation products and services.

A natural question which then arises from the stated hypothesis is: “What types of manufacturing and/or
services should we aim to attract?” The answer to this question must address both the demand and supply
sides of the equation. That is, does the market favour the production of such good(s) and/or service(s) i.e.
there is sufficient unmet demand, and are the requirements for a successful venture currently present in
Costa Rica?

While the reputation of Costa Rica as a leader among developing nations in the field of climate change policy
cannot be understated, any decision made by a foreign company to invest in Costa Rica – whether in a
product or a service – must be based on sound financial reasoning as measured by Return on Investment
(ROI) or analogous measures. The value added to the Costa Rica economy through FDI would come from the
value differential – value of goods/services exported net the value of inputs. This necessitates that the target
segment base be large (it is for this reason more than any other that the export markets are the focus of this
study) and growing at a healthy pace. While the Costa Rican government provides incentives to attract FDI
such as the exemption of income taxes for the first eight years for companies present in “Zonas Francas”5 or
“free trade zones”, other incentives such as free land or land subsidies are not provided. The decision to
invest in the production of manufacturing facilities must therefore make economic sense under the
applicable conditions.

The supply side of the equation – determining whether the selected good(s) and/or service(s) could be
produced in Costa Rica in its current economic standing – is of equal importance. Attracting investment
would mean conducting a rigorous analysis to ensure that the necessary variables needed to make a venture
successful were indeed available. These could include labour (both quantity and quality), transportation
infrastructure, raw materials, land, and a legal framework to name a few. Adding to the challenge is that this
list of variables may differ greatly between one type of product and another. For instance, the production of
biofuel is driven nearly exclusively by the cost of agriculturally suitable land and unskilled labour6.
Alternatively, the production of mechanical components for wind turbines depends far more on the
availability of skilled labour and suitable transportation infrastructure7.

Market Growth
Information on the demand side of the equation i.e. determining whether a market exists for the production
of goods and services was obtained through a variety of public sources. Since the focus of this project is
export, the anticipated global demand of various clean energy technologies was viewed. This is shown in
Figure 1.

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 Figure 1 – Expected growth in market size of various clean energy sources8

Broadly speaking, the growth between the three segments – solar (including both PV and thermal), biofuel,
and wind – is relatively balanced. It is estimated that the wind market in 2019 will be worth over $100 billion
dollars9. One of the objectives of this study is to highlight a segment within the wind energy manufacturing
industry where Costa Rica holds a competitive advantage so that it can be an active player in this market.

A number of interviews10 conducted in early phases of this project highlighted the strength of the
manufacturing sector within Costa Rica. The success that Costa Rica has enjoyed with computer chips (Intel)
and medical devices underscore the country’s core competency in manufacturing. What was less clear was
whether the labour force could also be a source of competitive advantage in the manufacturing sector as it
pertains to wind turbines.

Importance of Export
The Costa Rican population of 4.5 million would hardly be attractive for companies targeting the North
American and/or European markets. Adding to the challenge is the government owned monopoly in the
energy market which considerably diminishes Costa Rica’s attractiveness to foreign investors.

Competitors
In competing for FDI, countries are often grouped geographically. Thus, Costa Rica’s “competitors” as
traditionally defined include other countries in Latin America and the Caribbean. While the competing
countries for Intel in the mid-1990s were indeed in Latin America11 (Brazil, Chile, and Mexico), the underlying
reasoning need not always apply.

A somewhat more accurate definition of “competitor” would be based on a combination of economic criteria
such as population and GDP per capita (purchasing power parity). However, even this approach fails to take
into consideration the means by which GDP is created. Indeed, a number of Latin American countries which
have a higher GDP (PPP) per capita than Costa Rica can attribute that difference to an abundance of natural

8
resources rather than a more advanced economic makeup. The most notable examples of this are Chile
whose wealth in minerals and Venezuela whose oil reserves give them a GDP per capita (PPP) of $14,341 and
$12,201 respectively – significantly greater than Costa Rica’s $10,579.12

A more appropriate comparison would involve analyzing the makeup of the country’s economy – agricultural,
industrial, or service based. In the vein, a country that would be far more analogous to Costa Rica is Ireland
which went through a similar period of economic development in the 1960s. Of particular note is that the
Irish Industrial Development Authority redirected the focus of economic growth away from traditional
activities such as agriculture towards technology while simultaneously implementing public and economic
policies to attract FDI. As a result of this economic growth, Ireland now serves as an “offshore platform” for
the European Union (EU) specializing in service based economic output and light manufacturing. Not
surprisingly, nearly all of Ireland’s exports at the time went to Europe, with approximately 90% going to
Britain alone.

Costa Rica could potentially serve in a similar capacity for the North American market if it successfully
executes similar economic policies. A linear regression of two variables – the country’s educational level and
its economic performance – point out that Ireland was, for in a considerable period of time, lagging its peers.
A similar analysis done today illustrates that Costa Rica is in a similar situation; the level of economic
development, in particular in the service sector, lags behind where it should be based on education level.

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Foreign Direct Investment in Turbine Component Manufacturing

Preliminary research indicates that the manufacturing and design of components for wind energy technology
may be the most promising area of investment. The key drivers in this group are not land and unskilled labour
as is the case with biofuel but skilled labour and manufacturing infrastructure.

One of Costa Rica’s greatest sources of competitive advantage is its workforce, specifically its value per wage
rate in medium level technological jobs, a fact highlighted by the recent success in the production of
computer chips and medical devices. Other types of services where the Costa Rican workforce has
successfully carved out a niche that befits its skill set include assembly and test services as well as moderately
intensive research.

One of the key challenges facing Costa Rica today is the quality of the port infrastructure where the country is
currently ranked 128th in the world13. While plans are currently underway to develop an improved facility in
Puerto Limón in Costa Rica’s Caribbean coast, it is unclear whether this project will fully address this issue at
a competitive cost and whether it will be in operation quickly enough to attract FDI in the immediate future.

Perhaps the greatest single challenge resulting from transportation pertains to blades. In spite of the
significant capital cost of wind turbines – approximately €1.2 Million per MW – transportation of components
can increase the cost by up to 20%14. It is for this reason more than any other that companies in the turbine
generation business are moving towards a vertically integrated supply chain – one that minimizes the needs
to transport large, expensive components.

In addressing the question of FDI, we considered the possibility of manufacturing blades in Puntarenas where
we believed that the skills and infrastructure were available due to the presence of a yacht manufacturing
facilities. Because yachts are composed primarily of fibreglass, the same material used to made turbine
blades, we felt that there was the possibility that an industry focused on blade manufacturing could be set
up. However, the cost associated with shipping blades to Europe and North America raised questions about
cost competitiveness.

Figure 2 – Cost of wind turbine components15

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This limitation led us to focus on components with a high cost density – defined to be the cost per unit
weight. The value of this parameter is underscored by some of the goods which Costa Rica has successfully
integrated into its economy i.e. computer chips and medical devices. In this vein, the most promising turbine
components are the power convertor and transformer, which make up 5% and 4% of the cost respectively.
The skill set needed to accomplish this type of manufacturing are present in the country as a result of the
educational system and the technology transfer that has taken place as a result of Intel’s presence. The high
technical competence of the Costa Rican workforce in the manufacturing of electrical hardware further lends
weight in support of this argument.

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Wind Energy Production: Opportunities and Challenges

At the initiation of this study, our focus was on developing a strategy to attract FDI in the manufacturing
sector irrespective of whether this pertained to energy derived from solar power, wind, or biofuel. A number
of factors that came to bear as this project evolved, in particular insights from individuals in both the public
and private sectors with an intimate familiarity with Costa Rica, led us to shift direction so as to include not
only wind turbine component manufacturing but also on wind energy generation.

Of particular note was a meeting with MesoAmerica Energy, a branch of a private equity firm which has
experienced first-hand the challenges of running a wind energy generation business in Costa Rica. Prior to
this meeting, our interaction with organizations involved in energy production in Costa Rica had been limited
to individuals and organizations from the public sector i.e. CINDE, Procomer, U.S. Embassy, U.K. Embassy,
Costa Rican government officials, etc. and academic organizations i.e. INCAE. A balanced assessment of the
energy industry made it imperative that we obtain insights from the private sector as well.

Wind and Rain: A Supply Side Offset

A key observation pertaining to energy supply is that not only does Costa Rica have an abundance of both
wind and hydroelectric energy, but that their respect supplies are offset by approximately half a year. Thus,
the peak season for wind – the “dry” seasons in Costa Rica which lasts from December to May – is also the
season in which hydroelectric electricity is more limited due to a lack of rainfall. Conversely, the “wet” season
which lasts from June to November offers an abundance of rainfall needed to supply hydroelectric
powerplants.

This seasonal offset provides a type of “hedge” as renewable forms of energy are available year-round.
Unfortunately however, the latter resource is currently being used to supply the vast majority of the
country’s clean energy supply. This presents a number of significant risks including questions about the
supply vis-a-vis growing demand, an alleviated risk of energy shortage, and opportunity costs associated with
unused resources.

Figure 3 – Wind and rainfall patterns in Central Valley (Alajuela) and Guanacaste (Liberia)

Figure 3 shows the wind and rainfall patterns in Alajuela and Liberia. There are a three behind the selection
of these two locations. First, the most reliable meteorological data for wind and rainfall is collected at
airports. The two largest airports in Costa Rica, Juan Santamaría and Daniel Oduber Quirós, are located in
Alajuela and Liberia respectively. Secondly, it is of particular importance to examine wind and rainfall in the

12
Central Valley as this is home to the majority of the Costa Rican population. Lastly, the generally favourable
wind conditions found in Guanacaste merit the collection of data in this province. In reality, the production of
wind generation facilities would not necessarily be in Liberia but rather in a location with ideal wind
conditions.

Although rainfall and wind patterns provide a good indication of the seasonal offset of these two sources, a
more accurate assessment of renewable energy can be made by analyzing the power generation potential of
these two sources over the course of a year. Not surprisingly, the amount of hydroelectric and wind turbine
power available mimics the rainfall and wind patterns respectively. The variation in supply by season ensures
that Costa Rica’s energy supply year-round is clean. Unfortunately, however, nearly 80% of the total energy
supply in Costa Rica comes from hydroelectricity alone16 while the balance comes from a variety of other
sources including biomass, geothermal, and wind.

Figure 4 – Annual hydroelectric and wind energy potential17

Figure 5 – Energy generation portfolio of Costa Rica18

Alleviated Risk of Single Supply

A secondary but related item worth pointing out here is that rainfall, like any natural resources, cannot be
predicted accurately and consistently. Using only one renewable resource to meet the vast majority of the
country’s energy needs therefore exposes the country to the risk of energy shortage in the event that the
volume of rain over a given period of time falls significantly below expectations.

The production of energy production facilities as a result of this risk is not without precedent. As an example,
one may consider the energy complex near Volcan Arenal which hardly used thermal generation shortly after

13
it was constructed in the early 1980s. Subsequently, its use increased to a maximum of 17.4% in the year
1994 due, in large part, to a severe drought19.

The issues of growing demand and unpredictable supply notwithstanding, Costa Rica also needs to address
opportunity cost of not harnessing wind energy. The wind generation capacity of the country, while
tremendous, is arguably the largest renewable resource whose potential has not yet been fully realized.
Aggressive investment in the harnessing of this renewable energy supply may very well hold the key to
meeting the growth in future demand that the country will experience, reduce the risk of energy supply
constraints stemming from unusual weather patterns, and provide sustainable growth to the economy by
way of energy exports.

The potential for export driven revenue from energy generation may bear fruit if the sum of the current
energy supply stemming from hydroelectric powerplants, when combined with wind energy, exceeds the
demand within the country. Currently, approximately 8 million people in Central America do not have access
to electricity20. The supply mismatch between Costa Rica and its neighbours may very well manifest itself in
the form of economic opportunity if the government is willing to either directly invest in the generation of
wind energy or encourage development from the private sector through economic incentives.

Finally, it is worth mentioning that a significant barrier that would otherwise have discouraged foreign
investment in Costa Rica’s energy market – a lack of grid interconnectivity between various Central American
countries – has been alleviated through the Sistema de Interconexión Eléctrica de los Países de América
Central (SIEPAC). The removal of this technical obstacle effectively means that barring any political or
economic disputes, export of wind generated energy through Central America could be effectively
implemented.

Wind and Rain: Domestic Demand Side Analysis

The issue of seasonal supply notwithstanding, the prevalence of wind during the dry season also lends
credibility to greater investment due to issues related to the demand side of the equation. While the energy
demand in Costa Rica continues to grow, the general pattern of annual electricity demand has remained fairly
steady; the demand for energy tends to be greatest between November and April with a significant drop
between the months of May and August. The maximum instantaneous electricity demand recorded in
2008 was 1526 MW and occurred in the month of February21, the same month at which wind power has
historically been at its seasonal peak and rainfall at its seasonal trough. A quick view of Figure 4 and Figure
6 demonstrates that the electricity demand pattern is somewhat inconsistent with the availability of
hydroelectric power which accounts for most of Costa Rica’s supply. Conversely said, the electricity demand
tends to more closely follow the pattern of wind energy availability although the amount of variation in wind
potential is greater.

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 Figure 5 – Annual energy demand in Costa Rica (2005 – 2008)22

The framework of demand side analysis is not limited to annual assessments, however. Factors of human
behaviour over the course of a 24-hour day reveal a fairly reliable assessment of energy needs that lend
credibility to the case for greater wind energy production. The energy demand historically has tended to
reach a plateau at approximately 10am after which it remains relatively steady until 6pm at which time a
three hour peak commences.

An often cited criticism of wind23 is that unlike hydroelectric energy which can be converted to electricity at
will, it is only available when the wind is blowing. To test whether this observation was significantly
detrimental to the case for greater investment in wind, we conducted an analysis of wind data in Liberia,
Guanacaste over the course of the six months that make up Costa Rica’s “dry” season. The result was
surprising. The data, shown in Figure 7, indicated that wind speed reaches a plateau at around 11am and
remains fairly steady until approximately 6pm. Thus the supply is fairly steady through the course of an
afternoon. Furthermore, the data indicates that this pattern holds true for all six months of the “dry” season
although the actual wind speed varies. The general prevalence of this energy source during the day – when
most of the Costa Rican population is active – strengthens the argument for investment in this area.

A secondary but related argument against the above cited criticism comes from the impact that greater wind
energy production would have on hydroelectric energy supplies. Currently, hydroelectric power is the energy
source of choice during both the “wet” and “dry” seasons. Greater investment in wind energy generation
during the “dry” season would have the effect of lessening the need to use hydroelectric power during this
time of year. This, in turn, would help maintain higher water levels in reservoirs during the “dry” seasons
than has traditionally been the case. In this manner, the availability of “backup” energy supplies will be
greater thereby providing an alternative source should there be a decrease in wind for a sustained period of
time.

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 Figure 6 – Daily energy demand in Costa Rica (January – December)24

Figure 7 – Wind speed variation in Liberia, Guanacaste during “dry” season

Domestic Demand Side Growth

The seasonal offset between wind and rain along with the daily and seasonal demand variation are not the
only concerns that warrant a re-evaluation of wind’s place in the Costa Rican energy market. Of particular
interest in the long term is the growth of the Costa Rican population and economy, both of which will lead to
a rise in energy demand.

From 1990-2007, electricity demand in Costa Rica grew at an average annual rate of 5%. In 2008, the rate of
growth slowed to 2% due to the country's economic slowdown resulting from the global economic crisis. The
projection of demand over the course of the next two decades, illustrated in Figure 8, demonstrates the
increase in energy demand as the country grows.

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 Figure 8 – Growth in Costa Rica’s energy demand (2010 – 2030)25

Three scenarios for growth in energy demand are shown with a variation in the assumptions used. The
growth in demand is shown assuming low, average, and high growth rates. The price of electricity has been
kept constant in all three cases as a means of simplification. In practice, one can expect consumers to alter
their energy consumption behaviour based on price, however.

It is expected that the energy demand to rise by 50% and 150% in one and two decades’ time respectively
based on the “average” rise scenario. A more aggressive increase in energy consumption would lead to a
demand that is four times higher in 20 years than it is today. While Costa Rica currently meets its electricity
demand using renewable sources to generate over 90% of its electricity requirements, it is unclear whether
the sources currently being used will be enough to meet future needs.

Demand Rise in Transportation

The issue of demand is not limited to energy in the residential and industrial sectors. Currently, 100% of
Costa Rica’s transportation is powered by hydrocarbons26. In an article written by Laura Chinchilla in La
Nacion, she outlined a framework to address the issue of energy to power the country in the future. One of
the objectives outlined was to have a transport system that relies only on clean energy27. This goal is based
on a model whereby vehicles which currently use hydrocarbons such as petroleum and diesel are replaced by
vehicles which must be electrically charged.

Invariably, switching all of Costa Rica’s transport vehicles from fossil fuel to electric will lead to a massive rise
in energy demand. The ambitiousness of this goal is only amplified by the relatively short timeframe by which
the Chinchilla government aims to obtain carbon neutrality: 11 years at the time of this study. Unless the
government intends to incorporate clean and readily available sources of energy such as wind into the
portfolio of energy resources, it is likely that this goal will either only be partially attained or will come at the
cost of a steep increase in prices resulting from a demand surge. A third scenario would, of course, be the
status quo; a large and ever increasing number of hydrocarbon based vehicles contributing to the country’s
carbon emissions.

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Energy Demand: An Export Perspective
As we explored the challenges and opportunities in Costa Rica’s energy market, one of the items we
discovered of significant economic potential was the energy landscape in other Central American countries.
The lack of availability of electricity in other countries in the region, the projected economic and population
growth and with it growth in energy demand, and the price disparity (only amplified by the difference in
average incomes) all help to paint a picture of significant economic impact to the Costa Rican economy
through energy export.

Figure 9 – Energy availability and cost in various Central American countries28

While nearly all of Costa Rica has access to electricity, the energy situation in other Central American
countries is somewhat mixed. Of particular interest is Nicaragua where only 61% of the population has access
to electricity29. In the entire Central American region, approximately 8 million people still do not have access
to electricity.

This picture is incomplete without some words on the cost of electricity in Central America. Broadly speaking,
the price of electricity in other Central American countries is significantly higher than in Costa Rica. The price
of electricity in Nicaragua, for instance, is nearly 50% higher in both the residential and industrial sectors
vis-à-vis Costa Rica30. As the 40% of the Nicaraguan population which currently does not have electricity
obtains access, we can expect a rise in demand. Unless this rise coincides with a proportional rise in supply,
we can reasonably expect the price disparity to increase. This may present the opportunity for Costa Rica to
export energy. For Costa Rica to make use of this opportunity, the country will have to harness supply
sources that will not meet but exceed the domestic demand. As some of the points highlighted earlier in this
paper indicate, this will be challenging.

Figure 10 – Growth in energy prices in various Central American countries (1994 – 2007)31

The model of regional electricity export is one that must overcome potential technical, legal, political, and
economic issues. With the recent completion of the Sistema de Interconexion Electrica para America Central
(SEIPAC) agreement, many of the technical and legal issues have effectively been addressed. Thus, what

18
remains for SIEPAC to serve as a platform for transporting energy are the necessary economic criteria, in
particular the supply and demand mismatch across borders and resulting price disparity that will provide the
incentive for a country like Costa Rica to sell energy to its neighbours. What remains unclear is what roles the
private sector and public sector, in particular ARESEP and ICE, will play in any agreements to sell energy.

Figure 11 – Sistema de Interconexion Electrica para America Central32

Public Policy Challenges

Although a number of macroeconomic and geopolitical factors – stable democratic government, responsible
environmental stewardship (and perhaps even more importantly for FDI, the perception of responsible
environmental stewardship), strong and multiple renewable energy supplies, and a lack of oil and natural gas
(often cited as causes of the “resource curse”) – have positioned Costa Rica to reap economic rewards
through its location and climate, much of this potential remains unfulfilled. While this failure cannot be
attributed to any one factor alone, part of the cause is poorly drafted and executed public policy. In
particular, there are three major concerns with regards to Costa Rican public policy on the national level as it
relates to clean energy production:

1.) Public policy cannot be effectively implemented without first understanding the goals
2.) Public policy cannot be pursued in a vacuum
3.) Goals must be extremely specific and timed

Fully understanding the objectives

At the heart of public policies – environmental, political, social, or otherwise – lie objectives. These must be
defined clearly and early on in a manner that makes their purpose clear. To date, a number of energy related
economic policies that have been proposed or put in effect have been done so without complete
consideration of what the objective really was. A number of examples within the renewable energy industry
can be cited as evidence.

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One of the keys to becoming competitive generating electricity through wind turbine farms is to utilize
economies of scale to dilute certain fixed costs. While the cost of turbines varies by the number used in a
wind farm (ignoring the possibility of discounts associated with large orders), fixed costs such as the cost of
grid connection are independent of the number of turbines used. Currently, Autoridad Reguladora de
Servicios Público (ARESEP), the Costa Rican government’s branch responsible for regulating prices of public
utilities does not permit any company to build plants with an output capacity greater than 40MW (roughly
equivalent to 20 to 30 wind turbines), a fact that may step from concerns that large energy generating plants
may threaten the amount of influence ARESEP can exert on the market.

This limitation in size has the effect of thinning the operating margins of wind farms which, in turn, dissuades
foreign investment from Costa Rica in two ways. Firstly, it sends the wrong message to the investor
community by implying that the government is not only uninterested in pursuing clean energy policy but it is
actively taking steps to prevent its implementation. Secondly, it makes Costa Rica a far less attractive
destination to invest in by way of lowered Return on Investment (ROI) or alternatively, increasing the Internal
Rate of Return (IRR) – the required rate to break even on a project. Current IRR rates of wind energy
generation plants in the United States are approximately two thirds of what they are in Costa Rica: 11% vs.
17%33.

The price of electricity that ARESEP is currently paying – $0.059 per KW-hr – is currently enough to only cover
costs for certain wind farms. The price and longevity of contracts is therefore severely detrimental to
attracting foreign investment as it exposes energy providers to fluctuations in the Consumer Price Index (CPI)
i.e. inflation, as well as the exchange rate between the Colón and the U.S. Dollar. One possible means
through which this could be addressed is a feed-in tariff, a mechanism that would help accelerate Costa Rica
towards the attainment of 100% grid parity through the implementation of renewable energy sources such as
wind. Included in such a provision would be guaranteed grid access, long-term contracts, and prices which
reflect the cost of production of wind energy and make investing in this field attractive for private sector
firms.

A discussion of the Costa Rica’s energy market would be incomplete without some comments on the broader
issue of government owned monopolies. Access to electricity, like clean water, is necessary not only to
improve a nation’s standard of living but also to spur economic growth. The generally high demand
inelasticity associated with items necessary for survival such as clean water makes them very attractive for
entities in the private sector who are motivated by economic profit. Free market economies where
companies will price goods and services to maximize their profit creates the risk that prices may fall out of
reach of many people thereby not only impeding economic growth but also adversely impacting the average
person’s standard of living. Taken to an extreme, such scenarios can lead to social unrest as seen in
Cochabamba, Bolivia in the aftermath of water privatization in 1999.

Government own monopolies significantly mitigate this risk by placing a cap on the price such that energy
becomes affordable to the vast majority of society. This provides the necessary supply needed to grow the
economy and improve citizens’ quality of life. However, such an economic framework must function in such a
manner that it not only efficiently distributes energy to the masses but does so without losing sight of
incentives that will encourage economic growth. Many of the Costa Rican government’s policies as applied to
clean energy production, while effective in distributing energy to the masses, fail in this regard.

Policy in a Vacuum
Public policy as viewed through legislation alone is almost never enough to make an impact. Rather, policy
must be pursued in conjunction with economic and social incentives in order to bring change. While Costa
Rica has very publicly made efforts to market itself as an environmentally responsible and socially progressive

20
country, it has not put in place many of the necessary economic incentives needed to reach the goals implied
from stated policies. This is clearly demonstrated in the relationship that ARESEP has hitherto had with wind
energy generation firms.

Effectively implementing the stated public policies necessitates changes in economic and/or business policy
to provide the right conditions to meet these objectives. Improving coordination between government
agencies to create competitive rates for clean energy production, increasing the size limit of wind farms, and
the implementation of a feed-in tariff are all economic measures that are better aligned with the objective of
achieving carbon neutrality without compromising economic growth.

Arguably the single best source of information on the future of the Costa Rican energy market is outlined in
the National Energy Plan (Plan Nacional de Energía). A number of key points highlighted in this plan point to
the government’s desire to move towards a fully renewable energy portfolio. However, an objective
assessment of the policies raises questions about whether these policies will be effective given the lack of
economic incentives. Some of the more important points as they pertain to wind energy are highlighted
below.

The first objective highlighted in the “Principles and Objectives” section states the need for “Security of
energy supply”. This goal is repeated in the fourth of five strategic objectives which calls for “Increasing the
diversification of energy supply”. It is difficult understand how such a goal can be accomplished if nearly all
of the renewable energy in Costa Rica comes from one source: hydroelectric power. As the lack of rainfall in
1994 highlighted, the country will remain at risk if no action is taken to expand the portfolio of energy
beyond one source. Furthermore, the seasonal offset of wind and rainfall that was highlighted earlier in this
study only raises more questions about the government’s actual strategy vis-a-vis its stated objectives.

The second point in “Principles and Values” emphasizes the need for “indigenous sources of energy”. It is the
second word – “sources” – which most urgently needs to be addressed. While hydroelectric power is indeed
indigenous, it makes up such a large part of the energy portfolio that it would not be drastic to say that
“sources” could easily be replaced by the singular form of the word: “source”.

The final point in the “Principles and Values” section calls for “Cooperative effort between public and
private sectors”. The amount of influence that ARESEP and ICE have on the market renders the private
sector a relatively insignificant part of the energy picture in Costa Rica. However, the rise in demand that
country will experience in the next two decades raises questions as to whether the public sector will be
capable of meeting the challenges alone. Adding to this challenge are some of the budgetary constraints that
the government is currently facing.

Goal Definition
While Costa Rica obtains nearly all of its electricity through renewable means, the justification of the
breakdown of energy sources remains unclear. A more effective and efficient public policy would entail a
clear breakdown of energy sources in addition to clear justification for why those breakdowns are what they
are . Indeed, an even better solution would involve different breakdowns depending not only on region but
also by time of year. For instance, Guanacaste with its abundance of wind may opt for this energy source to
take up a much larger share of the total energy supply. Similarly, the energy breakdown of the country may
be such that a larger proportion of energy is generated in hydroelectric powerplants during the “wet” season
and a smaller proportion during the “dry” season when wind provides the majority of energy.

21
Conclusions and Recommendations

Foreign Direct Investment in Turbine Component Manufacturing

The greatest challenges to the development of a wind turbine manufacturing industry in Costa Rica come
from a lack of adequate transportation infrastructure and the high cost associated with shipping large
components overseas. It seems highly unlikely that Costa Rica will be able to resolve these obstacles in the
near future, an absolute requirement for the development of a sustainable economic “cluster”.

The most promising area within wind turbine manufacturing business where Costa Rica could successfully
compete is the production of high “cost density” components. Specifically, the power convertor and
transformer units which constitute approximately 5% and 4% of the cost of a turbine are the best candidates.
The country’s success in the development of electric chips lends credibility to the production of these
components as does their relatively small size vis-a-vis blades. Before any decision to invest in production
facilities is made in Costa Rica however, a more detailed analysis of cost breakdown of subcomponents
should be conducted.

Wind Energy Production

The key recommendation from the study of energy generation detailed in this report is very clear: Costa Rica
needs to invest aggressively in wind energy generation. The substantiation for this recommendation comes
from analyzing both the supply and demand sides of the equation. The more challenging part is determining
and executing a set of steps to attain this goal. We believe that while a number of challenges lie ahead for
Costa Rica in the context of the energy market, the key to solving many of them lie in aligning economic and
public policies. The following recommendations will help to address these issues:

1. Reassessment of Pricing
Although the Costa Rican government has successfully brought affordable energy to its people, this
success has come at the detriment of the investment from the private sector. As the demand for
energy grows, the private sector may very well hold the potential to address this challenge. For it to
play an active role, the government will need to provide economic incentives starting with a more
competitive pricing model for energy generation.

2. Reassessment of Private Sector in Energy Generation

The production and distribution of energy can be broadly broken down into three phases:
generation, transportation, and distribution. Currently, the Costa Rican government has control of all
three of these stages. While the second and third stage can be kept under government control in the
foreseeable future, the first – generation – needs to be liberalized. It is doubtful that the growth in
demand will be addressed by the public sector alone. Allowing the private sector to generate more
electricity will help address the supply side of the equation. This strategy, however, will have to take
place in conjunction with the reassessment of pricing mentioned above as incentives for private
sector firms to enter this market must be present.

3. Further Analysis of Energy Exports

In the longer term, the Costa Rican government should strongly consider energy export via SIEPAC if
it can successfully meet national demand. Because the models of energy growth are subject to
changes, it is remains to be seen where future energy supply will remain relative to demand. In the
event that the country does produce more energy than required, the decision to export energy
should be made in lieu of lowering production to demand levels.

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About the Author

Mian Hussain is an MBA student (Class of 2011) at the School of Management at Yale University. He
completed this project over the course of June and July, 2010 as part of his MBA summer internship. His work
was funded exclusively by Yale University through the Dean’s Fellowship Grant and Emerging Markets Grant.
He can be reached via email at mian.m.hussain@yale.edu

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1
“Building a Cluster: Electronics and Information Technology in Costa Rica” Harvard Business Review Case 9-703-422
2
LavanGuardia Website - http://www.lavanguardia.es/premium/publica/publica?COMPID=53410660334& ...
ID_PAGINA= 22088&ID_FORMATO=9&turbourl=false
3
“¿Por Qué Invertir En Centroamérica?” Roy Zuñiga (INCAE Business School)
4
Interview – Lawrence Pratt (INCAE Business School), June 16th 2010
5 nd
Interview – Catherine Reuben (CINDE), June 22 2010
6
Interview – Lawrence Pratt (INCAE Business School), June 16th 2010
7 th
Interview – Jay Gallegos (MesoAmerica Energy), June 30 2010
8
CleanEdge Website - http://www.cleanedge.com
9
CleanEdge Website - http://www.cleanedge.com
10
Interviews – Albán Sánchez (Procomer), Catherine Reuben (CINDE), Mauricio Castro (Fundecooperacion), Daira
Gómez (CEGESTE), Lawrence Pratt (INCAE)
11
“Building a Cluster: Electronics and Information Technology in Costa Rica” Harvard Business Review Case 9-703-422
12
The International Monetary Fund
13
“The Global Competitiveness Report, 2009 – 2010” The World Economic Forum
14
“The Economics of Wind Energy” The European Wind Energy Association, March 2009
15
“The Economics of Wind Energy” The European Wind Energy Association, March 2009
16
“Plan De Expansion de la Generacion Electrica Periodo 2010 – 2021” Instituto Costarricense de Electridad
17
“Plan De Expansion de la Generacion Electrica Periodo 2010 – 2021” Instituto Costarricense de Electridad
18
“Plan De Expansion de la Generacion Electrica Periodo 2010 – 2021” Instituto Costarricense de Electridad
19
“Plan De Expansion de la Generacion Electrica Periodo 2010 – 2021” Instituto Costarricense de Electridad
20
“Plan De Expansion de la Generacion Electrica Periodo 2010 – 2021” Instituto Costarricense de Electridad
21
“Plan De Expansion de la Generacion Electrica Periodo 2010 – 2021” Instituto Costarricense de Electridad
22
“Plan De Expansion de la Generacion Electrica Periodo 2010 – 2021” Instituto Costarricense de Electridad
23
“Plan De Expansion de la Generacion Electrica Periodo 2010 – 2021” Instituto Costarricense de Electridad
24
“Plan De Expansion de la Generacion Electrica Periodo 2010 – 2021” Instituto Costarricense de Electridad
25
“Plan De Expansion de la Generacion Electrica Periodo 2010 – 2021” Instituto Costarricense de Electridad
26
“Plan De Expansion de la Generacion Electrica Periodo 2010 – 2021” Instituto Costarricense de Electridad
27
La Nacion Article – http://www.nacion.com/2010-07-04/Opinion/Foro/Opinion2433870.aspx
28
“Plan De Expansion de la Generacion Electrica Periodo 2010 – 2021” Instituto Costarricense de Electridad
29
“Plan De Expansion de la Generacion Electrica Periodo 2010 – 2021” Instituto Costarricense de Electridad
30
“Plan De Expansion de la Generacion Electrica Periodo 2010 – 2021” Instituto Costarricense de Electridad
31
“Plan De Expansion de la Generacion Electrica Periodo 2010 – 2021” Instituto Costarricense de Electridad
32
“Plan De Expansion de la Generacion Electrica Periodo 2010 – 2021” Instituto Costarricense de Electridad
33 th
Interview – Jay Gallegos (MesoAmerica Energy), June 30 2010

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