Thursday, October 23, 2008

Nepal is not Bhutan

It's counter-productive to push for the Bhutan model here

When it comes to Nepal's water resources, talk of emulating Bhutan tops the agenda for so-called hydro-experts, policymakers, activists and a growing number of ordinary Nepalis. Dissenters are branded ultra-nationalist, and many say that we should stop complaining about the country being 'sold' every time a treaty is signed.

The claim is made that, thanks to the Druk model, Bhutan's per capita income is now at $1,300 (Wikipedia, March 2006). The standard response is that if a country expels a quarter of its population, as Bhutan has done with its citizens of Nepali origin, its per capita income could easily show a 33 percent rise.

The real story is somewhere in between. Bhutan did expel over 100,000 citizens. But it is also reaping benefit from the Chukha project (336 MW) and is already developing Tala (1020 MW). There is limited domestic demand for the power generated, given that Bhutan now has a population of just about half-a-million, as well as a limited transmission/distribution network. Exporting electricity to India is the only financially viable alternative.

Bhutan earns substantial profit from this export due to the financing model it uses. Sixty percent of the investment for any hydro project is provided as a grant, and the rest is a term loan. Technically, the project's total cost is slashed by 60 percent and therefore the cost of generation also goes down by roughly half.

For example, Chilime electricity costs Rs 2.77/kWh to generate. Under Bhutan's financing mechanism, its cost per kWh would drop to approximately Rs 1.40. At that price, we could still make a substantial profit even if we export to India at Bhutan's price, Rs 3.20/kWh (recently increased from Rs 2.40).

Sounds good, but there is a catch. In the 60 years that India has 'assisted' Nepal in developing a number of hydropower projects, we haven't been offered a financing model similar to that used in Bhutan. On the contrary, every time a treaty is signed between India and Nepal, Nepalis feel cheated.

The latest treaty between Nepal and India on the border Mahakali River illustrates this clearly. The slogan being bandied around at that time was 'half the water and electricity to each country'. Nepal's parliament ratified the treaty in the belief that we were securing 50 percent each of the water and electricity generated from Mahakali for Nepal. But close scrutiny reveals that Nepal actually gets only 3.5 percent of water, 96.5 percent going to India due to a proviso citing 'without prejudice to existing prior consumptive use' in Article 3. Thus it is heavily skewed towards India.

Further, the Bhutan model works because Bhutan is India's protectorate and the latter looks after Bhutan's defense and foreign affairs. Nepalis are unlikely to accept such an arrangement, and so chances are that we will not be treated on par with Bhutan. Despite knowing this, Nepali politicians, bureaucrats, businessmen, and bankers keep getting excited about the Bhutan model and clamoring for it. It is common sense that India is uncomfortable about being dependent on an independent Nepal. There could be one way out. If the security of such a project were to be guaranteed by, say, the Indian Army, the comfort level would go up significantly. But there would surely be resistance to this in Nepal.

It looks as if the only solution in sight is for Nepal and India to act in good faith and be mutually magnanimous. And most importantly, stop focusing on any single model of cooperation.

(Published as an analysis in Nepali Times of 8 - 14 Sept 2006, Issue #314)

Wednesday, October 22, 2008

Flood Control and Irrigation: First and Second Priority of India

India's union water resources minister Saif Uddin Soz has been frank and honest in admitting, with Navin Singh Khadka, BBC Nepali Service, on 12 September 2008, that “Our main interest is flood control and irrigation. Those are our first and second priority. If we get hydroelectricity as by product, that will be a bonus for us.” A transcript of the same has been published in Nepali Times weekly, 19-25 Sept 2008#418.

But Nepali hydrocracy (bureaucrats, intellectuals and politicos related to hydropower) still firmly believes that what India wants is the hydropower. You will remember me opining as follow in this respect. I urge you to review it in the new light.

It’s Fresh Water, Not Energy
One thing is common in all these treaties and agreements – ensuring fresh water for India. Without spelling it out explicitly, Nepal’s right to water in these rivers have been ceded. The issue in terms of downstream benefit in the case of reservoir projects is relatively easy to understand (some politicos refuse to understand the value of stored water while going about lamenting that water flowing in rivers, for which no one will be willing to pay a price without adding spatial or temporal value to it, is going awaste). West Seti project, for example, augments the dry season flow in the downstream areas in India by 90 m3/s, equivalent to 7.77 billion liters per day. In order to understand the value of such water one needs to know that Nepal is planning to invest in the order of Rs 30 billion to bring 170 million liters per day into Kathmandu. Had West Seti project been conceptualized as a multipurpose project, there would not have been an issue of downstream benefit to India. However, as there are no plans for Nepal to benefit from the augmented flow, India will receive such stored water free of cost, besides benefiting from flood control benefits. The issue here is why Nepal should inundate over 4,000 hectares of its land (to build the reservoir and due to inundation in Banke district as a result of Laxmanpur barrage and augmented flow) and displace over 30,000 people just to provide additional water to India during dry season, free of cost. Politicos and bureaucrats sermonize that Nepal is free to use such water while it flows within Nepal. But without a multipurpose project being conceptualized for Nepal to use such water, India, after using the augmented flow during one season, will start asserting the principle of “existing prior consumptive use” and Nepal will lose the right over such bodies of water permanently. This principle has already been used in structuring Mahakali Treaty to the disadvantage of Nepal. This is one way of gifting precious fresh water produced by storing it in Nepal to India.

One will need to study Columbia Treaty under which Canada is compensated for losing alternative use of the land inundated and also for augmented flow in the dry season from USA, besides the power benefit shared between the two countries for constructing the reservoir project. Nepal should have insisted on using this treaty as a precedent in getting recompense for land mass lost due to submergence (including forest resources, wild life, existing infrastructure, etc.) in the case of West Seti project. But …

Another way Nepal is ceding its right to water becomes apparent with some difficulty. Run of the river projects like Upper Karnali and Arun III do not generate augmented flow and, hence, apparently, no water related issues are involved. But an in depth study will make it clear that water issue is involved even in these projects. Section 20 of Electricity Regulation, 1993 guarantees “Right on Water Resources” which says that “The licensee, who has obtained license for production of electricity, shall have the right to use the water resources for the works as mentioned in the license to the extent of such place and quantity as specified in the license.” As stipulated by this section someone possessing a license to a specific site is guaranteed that no consumptive use of water will be undertaken in the upstream areas of the project, which might entail reduction of flow to the project site. By getting various “investors” to secure licenses to sites in Nepal, India has succeeded in ensuring that Nepal is forced to refrain from using the water for consumptive uses in these areas. In this manner too downstream flow to the Ganges is successfully secured with the issuance of each license and Nepal misses an opportunity to use such water, for example, to irrigate its arable land. In order to put things in proper perspective, one needs to remember that the Ganges receives 41% of its flow from Nepal in the wet season and 75% in the dry season.

On the other hand, although quite a few of Nepal’s hydrocracy (bureaucrats, intellectuals and politicos related to hydropower) believe that India badly needs electricity from Nepal, time has already proven that it’s not so. Take the example of West Seti. If India was badly in need of electricity from this project, Indians would have made sure that this project was built more than a decade ago. In other words, they would not have allowed this project to hibernate for one and a half decade. Same conclusion could be drawn from Mahakali Treaty as well. The detailed project report (DPR) for Pancheswar project was supposed to be ready within six months of execution of this treaty. It’s been over a decade now but the DPR is nowhere near sight. From this it could be easily seen that India is not that desperate for electricity from the rivers in Nepal, as is being perceived (and also propagated) by Nepal’s hydrocracy. If indeed India was starving for electricity she could have easily ensured that Pancheswar project (6,480 MW from storage project and 240 MW from reregulating dam) is built and, probably, commissioned by now. By getting Nepal to sign on the dotted lines in the treaty document, India succeeded in legitimizing the use of water in excess of what she is entitled to (50% of the water in Mahakali – deemed to be a border River), which she had been illegitimately using prior to execution of the treaty. And it’s also not that difficult to see that she is in no hurry to get this project commissioned

Tuesday, October 21, 2008

Hydropower Development - Irrelevant Debate of Small vs. Big

Ever since Schumacher wrote his influential book “Small is Beautiful,” there is a raging debate as to whether Nepal should pursue small hydro development primarily for domestic and local use, or it should go for big dams with electricity for export. On the one side, there are people who firmly believe that “small is beautiful” while people on the other extreme of the spectrum chant the Mantra that “big is bountiful.” They consider their respective mantras very sacred and refuse outright others view. As it is, what is small and what is big is very arbitrary. In India, a project of up to 25 MW installed capacity is deemed to be small while in Pakistan this threshold is fixed at 50 MW. But in Nepal, a project of up to 10 MW is categorized as small.

Economic Linkages
Instead of arguing whether a small or big hydropower project is good for Nepal, the assessment of whether a project is “good” for Nepal must be judged from its impact on and contribution to the economy of the nation. Such an assessment can be made by examining/analyzing various linkages to the economy like backward, forward, investment and fiscal linkages of specific projects. In this endeavor, this paper is attempting to examine/analyze the linkages to the economy of Nepal using West Seti hydropower project, 750 MW, undertaken by Snowy Mountain Engineering Corporation (SMEC), to illustrate the point.

Backward Linkage
Hydropower projects are of capital intensive nature, entailing high initial investment. Depending on the nature of backward linkages of a specific project, the contribution of each project to the country’s economy can be assessed by evaluating how much of the initial investment is retained by the economy, resulting in employment generation, higher level of industrialization, increased contribution to foreign exchange reserve, capacity enhancement and capital formation.

Absorption capacity of the economy also dictates the value/volume of the backward linkage. Obviously, if closer to a hundred percent of the initial investment percolates into the economy, the contribution of such a project to the economy due to backward linkage will be very high. Conversely, if the economy is able to retain very little of the initial investment then the benefit accruing to the economy from such a project will be proportionately low. From this perspective, a project which makes substantial contribution to the economy due to backward linkage is good for the country and vice versa. It is now time to see how backward linkage takes place or fails to take place.

As mentioned above, this write-up attempts to estimate the contribution to the Nepali economy by the West Seti project due to backward linkage, to drive the point home. For this purpose, one needs to take a look at the structure of the initial investment[1] which is as follows (the amounts are inclusive of contingency at the rate of 15% for civil works and at 10% for equipment, project management and resettlement, as provided for in the Detailed Engineering Report of the project):

Of the total cost of civil works of $ 469 million, most of it will be incurred for the procurement of cement, steel bars and other construction materials. Although there are two cement factories (other factories mainly grind clinker imported from India and fill in sacks) the production capacity of these are not adequate even to meet the present domestic demand. And there also are a number of factories producing steel bars in Nepal but these too are unable to meet domestic demand (and, moreover, as these use imported raw materials, the percolation from the use of such steel bars into the Nepali economy is very little). Therefore, the requirement of this project will have to be met by imports. The project will, however, be able to source for gravel and sand within Nepal and it is estimated to cost about $ 1 million.

As Nepal is yet to set up industries manufacturing/fabricating electro-mechanical equipment even for projects below 10 MW, the entire budget of $ 180 million is likely to be spent on imports of electro-mechanical equipment for the project. Same will be the case of investment of $ 22 million in the transmission line. However, it can be fairly assumed that it will cost about $ 1 million in Nepali workers in the installation/erection of electro-mechanical equipment and transmission network.

The resettlement entails purchasing land and building houses for the displaced populace and the land and construction materials is expected to cost 50% of the budget. Project management, to be the responsibility of SMEC, is expected to be predominantly expatriate affair and about 10% is expected to be spent on the technocrats from Nepal.

SMEC has been making it public that 5,000 unskilled workers are expected to get employment during the construction period (as have been seen during the construction of most of the hydropower projects, most of the skilled workers will be sourced from foreign countries). Over the construction period, lasting 5.5 years, the workforce at the construction site will be relatively small in the initial years which will peak during the 4th year and will taper off as the time of commissioning of the plant nears. Therefore, it is estimated that the construction of the project will entail 165,000 worker/months. Total payment to the workers over the construction period is estimated amount $ 15 million at the rate of Rs 6,000 per worker/month.

Multilateral Investment Guarantee Agency (MIGA), being a member of the World Bank group, the premium of $ 34 million will be spent overseas. Similarly, as debt financing for the project will be coming from foreign financial intermediaries, the interest during construction and other financing costs will not percolate into Nepali economy. It is expected that about $ 0.2 million will be spent on lawyers from Nepal and the balance of $ 17.8 million will be paid out to foreign lawyers. SMEC is entitled to a development cost of $ 27 million for preparing the project and it can be fairly assumed that about 10% of this amount will be spent in Nepal.

In this manner, of the total initial investment of $ 1,097 million, about $ 39 million will be spent in Nepal – amounting to 3.56% percolation into the domestic economy. Therefore, the employment generation, level of industrialization, capacity enhancement and capital formation will be limited by this percentage. In the similar vein, although this project entails foreign direct investment of $ 1,097 million but the contribution to foreign exchange reserve of Nepal (another form of backward linkage) will be limited to $ 39 million that will be spent in Nepal. Rest will come to Nepal as the foreign direct investment and will desert the country immediately due to outlays in foreign countries.

Had the absorption capacity of Nepali economy been better, the percolation or backward linkage benefit of this project would have been higher. Conversely, backward linkage benefit of other projects which are not too dependent on foreign sources will be higher. An ideal hydropower project from this perspective will result in 50% or more absorption of the initial investment. Therefore, the debate should be over choosing projects that results in higher backward linkage benefit based on the absorption capacity of the economy. It should also be remembered that the absorption capacity of an economy is not static. It grows with the industrialization of the country. Today backward linkage benefit from this type of project is less than 5% but within a couple of decades it will be closer to 50%. Therefore, from the perspective of absorption capacity of the economy West Seti project is not an ideal size in the near future but it will become an ideal size in a couple of decades.

Forward Linkage
Another important way a hydropower project can benefit an economy is due to the forward linkage benefit which entails using the electricity domestically. Use of electricity by an economy results in multiplier effect on the economy resulting in employment generation, higher level of industrialization, increased contribution to foreign exchange reserve, capacity enhancement and capital formation. The electricity, upon it becoming available, can be used in all sectors. It can be used, for example, in agro-processing, like tea which is currently processed using furnace oil or firewood. With this one change economy will benefit from decrease in import of fossil fuel that drains hard currency, decrease in deforestation and decrease in environmental pollution. Similarly, by using electricity for irrigation, farmers, consequently the economy can benefit due to cultivation of multiple crop, cash crop, etc.

Currently industrialization in Nepal is stifled due to non-availability of abundant electric energy. Even existing industries have to rely on fossil fuels which are not cost effective – resulting in higher cost of production that impacts both the industry and its consumers. But it also drains foreign exchange reserve and also results in environmental pollution due to emission of greenhouse gasses. The fate of transport sector is also not different from the industry which is heavily dependent on imported fossil fuel requiring convertible foreign exchange and resulting in environmental pollution in massive scale. Similar parallels can be drawn in connection with tourism, health, education and domestic sectors.

From the above it is clear that use of electricity generated by a project results in import substitution to an extent and, therefore, positively impacts foreign exchange reserve. However, there are “economists” who believe that exporting electricity from such a project to India helps mitigate the problem of balance of payment deficit of Indian currency – to the extent of total revenue generated by this project by exporting electricity. This, unfortunately, is untrue which can be substantiated by looking at future cash flow of the project subsequent to its commissioning. For the duration of debt service period of about 15 years, of the total revenue generated by this project a large portion will be used up in the payment of interest on the debt and repayment of a part of the principal. Anything left after meeting the debt service requirement as such and operation and maintenance cost will be distributed as dividend of which only 15% will reach Nepal. However, as Government of Nepal is borrowing money to invest in the equity of this project company, most of the money from dividend in the hands of GoN will be spent in meeting this part of the debt service obligation. Therefore, the only “foreign exchange” that will enter and stay in Nepal in the first 15 years of project operation are the energy and capacity royalties, which adds up to about 2.66% of the total export revenue in the case of this project (this is further elaborated under fiscal linkage below).

If the electricity generated from a project like West Seti is to be used domestically, the forward linkage benefit to Nepali economy would have been tremendous. In order to simplify the matter, as only 10% of electricity generated from this project will be available to the Nepali economy[2], we can award it 10% mark for forward linkage.

From the perspective of forward linkage, therefore, the debate should focus on use of the electricity domestically, instead of size, in order to ensure that Nepal benefits from the project. In other words, if a project is built for domestic consumption, irrespective of size it would be a better project than an export-oriented project.

Investment Linkage
Under investment linkage the economy will benefit due to construction and operation of the project from the perspective of return on investment. The return, in the hands of the recipient, will either be used as increased purchasing power which will result in employment generation or will be saved and invested again resulting in capital formation. If a project is fully financed domestically then the financial intermediaries would have earned interest on their investment and the equity holders would have received dividend both of which would have stayed in Nepali economy.

In the case of West Seti, as all debt is being sourced from foreign financial intermediaries and all equity investors are foreigners, except for 15% of GoN, almost all of the return on investment will not percolate into Nepali economy. If the GoN was to take up 15% equity in this project from domestic sources, at least 3.75% of the return from the project would have accrued to Nepal. But, as GoN is borrowing money to invest in this project whatever dividend GoN will receive from this project will flow right back to the lender in debt service. Therefore, this project gets less than 0.1% mark on this count.

It is now clear that the country’s economy gains due to construction and operation of a project as such if it is fully financed from domestic resources due to investment linkage. At this juncture, Nepal is not in a position to invest from its domestic resources in this sized project. However, in a couple of decades this will not be the case. Therefore, from the perspective of investment linkage, this sized project is not an ideal size now but with the gradual increase in the capacity to mobilize fund domestically even this sized project will become appropriate for Nepal.

Fiscal Linkage
The fiscal linkage of a project to the economy of the country manifests in its contribution to the treasury – in the form of payment of various rates, taxes and duties. A hydropower project’s fiscal linkage takes place in two stages – during construction period and post commissioning.

For the construction/erection of a hydropower plant, as described above, a lot of materials and equipment are required to be imported. The hydropower projects are entitled to exemption from custom duty on its import of plant, machinery and equipment, except for 1%. Exemption of value added tax (VAT) on the import of plant, machinery and equipment is applicable for projects up to 3 MW only and projects bigger than this size are required to pay VAT on import of such items. However, as this project is entitled to exemption from sales tax (applicable prior to imposition of VAT), the chances are high that GoN will interpret the legal provision to grant it exemption of VAT. In this manner, this project will be paying about $ 2 million as custom duty on the imports of electro-mechanical and transmission equipment at the rate of 1% during the construction period. This works out to 0.18% of the total initial investment. Apart from this, this project will not be making any contribution to government treasury during the construction period. Compared to this other projects (above 3 MW) would be contributing 2.31% of the total initial investment to the treasury – as 1% custom duty and 13% VAT on the electro-mechanical and transmission equipment. This works out to 7.79% of what other projects would have paid.

During the operational period a hydropower project is required to pay capacity royalty of Rs 100 per kW and energy royalty of 2% of the revenue during first 15 years of the project operation. Due to variation in plant capacity factor of each plant (which in turn is governed by the factors like hydrology, exceedence, etc.), the total contribution to the treasury in the form of royalty ranges from 2.4% to 2.85% of the total revenue of a power plant. Under the prevailing Electricity Act, 1992, the applicable rates for both capacity and energy royalty are common to all projects and this project will be paying 2.84% as royalties. Under current Nepal law, a hydropower project is required to pay income (corporate) tax at the rate of 20% of the net income post commissioning. However, West Seti project is exempt from paying income (corporate) tax. Therefore, this project will not be paying any taxes to GoN during the first 15 years’ operation, except for a very meager export tax of 0.05% of the revenue, which other projects do not pay. Whereas, other projects will be paying income tax at the rate of 20% of the net income, which works out to over 7% of the revenue in the first year and exceeds 14% after completion of debt service. Moreover, under the Project Agreement for this project GoN has exempted even the tax on interest paid out to the lenders and dividend distributed to equity holders/owners. Other projects do contribute to the national treasury through these taxes as well. Compared to this project, paying only 2.89% as royalties (and no income tax) other projects will be paying income tax additionally – this project less than 25% of what other projects will be paying.

Furthermore, as this is a reservoir type project, it augments the downstream flow during the dry season by 90 m3/s; equivalent to 7,770 million liters per day (MPLD). No arrangement has been made to receive recompense for this. No efforts seems to have been made even to emulate the precedent set by Columbia Treaty between Canada and USA or the agreement between Lesotho and South Africa.

From this it is clear that the fiscal linkage of West Seti project, both during the construction period and during the operation period, with the government treasury is tenuous at best. In other words, the contribution to the treasury of this project to the GoN is quite low compared to other projects (7.79% of what others pay during the construction period and one fourth of what others pay subsequent of completion of the project).

Conclusion: Mark-sheet
This project contributes 3.56% as backward linkage, 10% as forward linkage and 0.1% as investment linkage (the lower fiscal linkage contribution of this project is not considered here as it is not due to the size). From this it is clear that out of the aggregate of 300 marks this project’s tally is a meager 13.66. Therefore, the debate should not be as to the small or big project. A project’s advisability from national perspective must be decided on the basis of its score on above basis. If a project deserves at least 150 marks out of 300 then that project enriches the economy a lot than a project like West Seti.

Backward linkage of small and medium sized project now is higher than this sized project and this will increase with the increase in the absorption capacity of the economy. Similarly, if the electricity generated from a project is exported, there will be no the percolation into economy in terms of forward linkage. Moreover, foreign investment means percolation of benefit accruing from investment linkage in the foreign countries. Thus, foreign investment in export oriented project is a deadly combination which deprives Nepal of both forward and investment linkage. Conversely, even if the backward linkage is low, the project will contribute to the Nepali economy substantially if it is constructed for domestic consumption with domestic investment. In this way it is not the size that matters but how the project is structured.

(Published as a chapter of book compiled by Institute of Foreign Affairs titled "Water Resource Management of Nepal: A Strong Means for Sustainable National Development" in January 2008)

[1] Source: Detailed Engineering Report of West Seti Hydroelectric Project, prepared by SMEC International PTY. LTD., December 1997.
[2] Pursuant to the decision of Natural Resource and Means Committee of the Parliament, GoN is required to take 10% of the electric energy in kind, although the Project Agreement with the proponents of this project (as amended by 8th amendment) envisages receiving money in lieu of energy. In this paper, it is assumed that GoN will succeed in amending the project agreement to receive energy itself, instead of money in lieu, in order to conform to the Committee’s decision.

Monday, October 20, 2008

Not a drop to drink

It doesn’t matter whether a cat is black or white as long as Kathmandu Valley gets proper water supply

A country so rich in water resources has been a chronic failure in ensuring proper drinking water for citizens. Forget about the rest of the country, it can't do so in its own capital.
It doesn't matter whether a cat is black or white as long as it catches mice. It hardly matters who manages the water system for Kathmandu as long as the people get a reliable and affordable supply.

The Nepal Water Supply Corporation (NWSC) is getting most of the flak for mismanaging water supply. There are many countries in the world where public enterprises are as successful as private ones. Not so in Nepal. Most government corporations here have accumulated huge losses, their net worth is mostly negative.

Political interference is usually the reason. The board of directors is packed with cronies and there is non-transparent, non-competitive selection of chief executives who stay as long as their political bosses are around. Politicians use public enterprises as recruitment centers and as a source of perks and pelf for themselves and their kith and kin. Bottom line: most corporations lack corporate governance.

In order to insulate public sector enterprises from these evils, Kathmandu-based multilaterals have a standard prescription: foreign management. Two of Nepal's largest banks were handed over to outside managers under the financial sector reform with ambitious targets to be achieved in two years. Five years down the line and after spending Rs 7 billion of borrowed money, these banks have not shown substantial improvement. On Melamchi, the Asian Development Bank (ADB) has made funding of Melamchi conditional on the government handing over management of NWSC to foreign management.

The debate today is not for or against the Melamchi project. The government seems to be all for it. Yet, the ADB wants Kathmandu Valley's water supply to be managed by Severn Trent Water International Ltd, or else. Certain politicos and bureaucrats involved in selecting Severn Trent agree fully with the ADB. Whatever one may think about Minister Hisila Yami, she raises valid questions about this deal.

Severn Trent was the only bidder in all four rounds of the selection process, which was a one-horse race. The problem must lie in the criteria that enabled only one bidder to participate. If there was only one bidder, the net should have been cast wider.

But that is not the only problem dogging Melamchi today. Unfortunately for Severn Trent, it has been under a dark cloud in countries ranging from UK to Guyana, thus casting doubts on the ADB's reasons for favoring a discredited company.

It is now time for sanity to prevail. To preserve its own reputation it is not advisable for the ADB to back a questionable party and threaten to withdraw support for Melamchi unless Severn Trent is involved in the project. Now that Severn Trent has withdrawn its bid without even consulting ADB, there is a way forward.

Now, the criteria for the next selection process should be fine tuned so there are more bidders (one week's job), solicit international competitive bids (35 days) and select a party that is not blacklisted anywhere (a month). In this manner we can have an alternative party to work as management contractor in less than three months.

It's a win-win-win. The selection procedure will be kosher, the ADB will come out of it with its reputation largely intact and maybe (just maybe) Kathmanduites will get clean water in four years. It's time to stop over-reacting on this long-delayed project and get on with the job.

(Published in Nepali Times of 25 - 31 May 2007, #350)

Sunday, October 19, 2008

Modifying Melamchi – Single Purpose vs. Multipurpose

Diversion of water from Melamchi into Kathmandu valley was identified as a viable measure to remedy the water shortage problem of Kathmandu valley some thirty years ago. However, it gained momentum only in the early 1990s, especially after the end of the Panchayat system.

At that time it was initiated with twin goals of producing about 25 megawatt (MW) electricity and supplying the water to the valley simultaneously. The project was planned to be executed in three stages. In the first stage, water amounting to 170 million liters per day (MLPD) was to be diverted to the valley from the Melamchi River. In the second and third stages, similar amount of water was to be diverted from Yangri and Larke rivers.

But the first stage construction works, initially planned to be completed by 2006, is yet to commence. Since the first stage, the funding for which is reportedly ready, has not taken off as yet, the second and third stages are still a distant dream. Neither a concrete plan nor a proper financing arrangement has been put in place for the second and the third stages.

According to a projection made by Nepal Water Supply Corporation, there will be a demand of 310 MLPD of water for the Kathmandu valley in 2010 whereas the Melamchi project will be adding only about 170 MLPD during the dry season to the existing volume of supply. Melamchi is expected to be completed by 2013 at the earliest by when the demand for water supply in Kathmandu would have exceeded 350 MLPD.

Now the Kathmandu valley is getting 90 MLPD of water which means after the completion of the Melamchi project the water supply in the Kathmandu valley will reach 260 MLPD. That volume is insufficient in view of the projected demand of 350 MLPD in 2013. Besides, taking the officially acknowledged leakage level of 40 percent into consideration, the actual amount of water available in Kathmandu valley will be mere 156 MLPD even after augmenting it with the water diverted from Melamchi through the tunnel planned to be built. Therefore, even after the completion of Melamchi project as it is designed, the problem of water scarcity in Kathmandu valley will still persist. As ADB has forced a covenant in the loan documents requiring escalation of tariff by almost 60 percent on current prices (two increases of 15 percent each on the 2004 price level), the water tariff will escalate without any reprieve in the water shortage problem.

The project, as initially designed, involved the construction of a tunnel from Nukute in Melamchi River (located at an altitude of 1700 meters) to bring water down to Sundarijal (1400 meters) thereby creating a head of 300 meters so that about 25 MW power could be generated. But the idea of generating hydropower was later abandoned claiming that it was not feasible. It is true that having to dig 27-kilometre long tunnel just to generate about 25 MW of electricity sounds too expensive even at a cursory glance. But the people ignored the fact that the tunnel has to be constructed anyway to divert water into Kathmandu valley. Therefore, if we were to generate power from the same water, the tunnel construction is as good as free for the power generation component, and incremental cost will be only for the construction of powerhouse, procurement of electro-mechanical equipment and erection thereof. This fact was completely ignored in deciding to abandon the hydropower component.

Proposed Revision
Our team came to a conclusion that as Bagmati has a head of 900 meters, between Kathmandu (altitude 1400m) and the potential powerhouse site on this river in the Terai (altitude 400m), 190 MW of power could be generated from this river. The only limitation is that Bagmati River is bereft of any water. If we can augment the water flow in the Bagmati, we can generate electricity by using the available head.

Therefore, our proposal is to modify the existing Melamchi project so that once completed it brings water not only from Melamchi for water supply in the Kathmandu valley but also from Yangri, Larke and Balephi. This will enable an investor to set up a 35 MW hydropower plant at Thimbu, just before the water enters the tunnel destined to the Kathmandu valley. This will result in an increased water level in the Bagmati, sufficient to generate additional hydropower downstream of Kathmandu valley as well as to irrigate 30,000 hectares of Bagmati plains in Sarlahi and Rautahat districts. In this manner, we will be bringing 1120 MLPD of water to the valley in the dry season. This is equivalent to about 13 cubic meters per second.

There are two uses of water—consumptive (drinking, cooking etc.) and non-consumptive (bathing, laundry etc.). Water used for bathing, laundry etc. constitutes about 85 percent of the consumption and such water flows back to the river and ground water system. You just need to filter/treat such water to make it reusable (it needs to be stressed here that the denizens in Kathmandu should discontinue present, regrettable and uncivilized, practice of draining untreated sewage and industrial effluent into the Bagmati River). Once we add 1120 MLPD of water to the existing supply of 90 MLPD after deducting the maximum that the residents of the valley will use (about 400 MLPD), we will still have 810 MLPD to spare. This volume will be augmented by the reflows of about 340 MLPD from non-consumptive uses.

With 1150 MLPD of water flowing down the Chovar gorge, we can build an 18-kilometre tunnel there to set up a 140 megawatt power plant. Building another tunnel of eight km starting from the tailrace of this power plant, will help set up another 50 MW power plant. So in total, we can generate 235 MW of power while supplying sufficient water to the people of the valley.
For irrigating 30,000 hectares of land in Sarlahi and Rautahat districts during dry season, a barrage on Bagmati River already exists, just a little north of East West Highway. Also a canal network in this area already exists for irrigation during the time when there is water flowing in this River. Thus, through this scheme, we can supply adequate amount of water to the valley denizens, generate much needed hydropower (thus mitigate load shedding problem) and irrigate the fertile lands of Terai enabling the farmers to plant multiple crops.

To attain these objectives what is needed is only to enlarge the diameter of the tunnel from Melamchi to Sundarijal from currently planned 3.7 meters to five meters. Hence, instead of going for a single purpose Melamchi, we should seek a multi-purpose Melamchi.

Financing
The modified multipurpose Melamchi will need an additional investment of about 400 million dollars for the hydropower component only. This change does not entail additional investment for the works related to current Melamchi scheme nor for the irrigation component. Actually, the need to build structures like intake and de-silting basin, planned to be built under current Melamchi scheme will be obviated if the multipurpose Melamchi is undertaken. Besides, it also needs to be remembered that second and third stage works under current Melamchi scheme (without funding in sight and plan on paper) to divert additional water from Yangri and Larke Rivers, also do not need extra financing after implementation of multipurpose Melamchi.

The funding for hydropower can be arranged through a debt-equity scheme of 75:25 ($ 300 million in debt and equity of $ 100 million). For equity financing, we can give the first priority to the people of Sindhupalchowk (water belonging to whom is to be diverted) to buy shares in the project followed by the people from Kavrepalanchowk, Kathmandu and whole of Nepal in that order. If we fail to mobilize needed equity in this way from within the country, we can invite foreign investors (like Indian investors who seem to be in a frenzy to invest in this sector). So, financing is not a problem. There are many financial intermediaries including large banks willing to provide debt financing for the hydropower sector.

The local people have been obstructing the construction works in various water projects including Melamchi and Middle Marshyangdi. This is because the local people lack a sense of ownership in these projects. They have shown their ardent interest to invest in the project in order to ensure an income stream for themselves in future. However, especially in a water supply project, it is not advisable to make the local stakeholders to invest as their expectation of returns from such project will not be met. This is because such projects do not generate adequate revenue stream to allow distribution of dividend to the shareholders (revenue stream will be adequate only to meet operational cost and will not even be able to meet debt service requirement). However, we can inculcate a sense of ownership by giving them an opportunity to invest in the power projects components thereby making them the owners of the project. Only then the locals will ensure that the construction works are expedited. The local stakeholders will make sure that the contractors don’t find excuses to delay the works. People of working class who are not able to invest in the project (for lack of savings) should be allowed to work in the project. They will earn income, some of which will be saved. They should be allowed to invest such saving in the project itself. In this way, they will not only have a source of income during the project implementation period but also after the completion of the project.

Challenges
For the modification of the Melamchi project in the proposed lines, the challenges at present are the politicos and bureaucracy of our own and that of the Asian Development Bank (ADB). We have been making presentations of our concept to the high level people in the government, political parties and ADB. But only a very few have succeeded to comprehend the full ramification of the vision and its merits for the region as a whole (not just Kathmandu valley). Even those who have succeeded to understand the concept have developed weak knees.

We should note that none of the capital intensive projects, including hydropower projects, undertaken by the government (or Nepal Electricity Authority) has completed in time or at the initially estimated cost. The glaring example is Middle Marshyangdi which was supposed to be finished by 2004 at the estimated cost of Rs. 13 billion. But Rs. 26 billion has already been spent and the completion is nowhere within sight. Similarly, Chilime, although touted as the best project so far (it did succeed in attracting and garnering many awards, though), was delayed by over four years and also incurred cost overrun as the original contractor abandoned the work. There is no track record of the government finishing any project within the prescribed time and cost. Nothing will be achieved as long as such tendency continues to prevail.

The current practice is to have separate engineering consultants and contractors. The contractors blame the consultants for faulty design and the latter blame the contractors for poor workmanship and in the bargain Nepal ends up suffering financially and economically (due to, for example, load shedding which is a result of delay in projects like Middle Marshyangdi). This has been a common experience in almost all projects so far. Therefore, there is no guarantee that the same fate will not befall on current Melamchi as there are separate consultants and contractors also in this project.

Modified Melamchi should have a different contracting and implementation mechanism. The contract should be granted to the best and capable party with a strict condition that they should complete the project within the stipulated time and cost (with no scope for any variation order), that any excuse to delay the project will not be entertained and that there will be penalty for each day of delay in the project completion and bonus for each day of early completion.(Published in New Business Age of March 2008)

Saturday, October 18, 2008

Pie in the sky (Mythical Hydro Dollars)

Nepal has a serious trade deficit with India. In the fiscal year 2005/6, the deficit was Rs 66 billion (imports Rs 107 billion and exports Rs 41 billion), according to the Economic Survey. The shortfall is very likely to rise if concrete mitigation measures are not implemented soon. And among them, hydropower export is being touted as being able to generate "hydro dollars." As Nepal Rastra Bank had to purchase a huge amount of Indian currency by paying for it with US dollars, the inflow of Indian rupees into Nepal's economy would conserve precious dollars. Hence, if the country does earn money by exporting hydropower, it will be as good as "hydro dollars."

Renowned economists (like Finance Minister Dr Ram Sharan Mahat and former vice chairman of the National Planning Commission Dr Shankar Sharma) have specifically claimed that earnings from the West Seti project alone would slash the trade deficit with India by 25 percent. One senior Indian bureaucrat has been assuring the elite and government bureaucrats that Nepal could earn a hundred billion rupees (10,000 crore in his words) by exporting electricity from 10,000 MW type projects. As he was referring to Indian currency, he must have meant Rs 160 billion in Nepal rupees. Therefore, it is time we examined whether power export from Nepal will really translate into hydro dollars, and, if yes, also assessed its magnitude.

Mitigating trade deficit
According to the Environmental Impact Assessment report publicized recently by the West Seti Hydro Ltd (WSHL), this 750 MW project will generate energy amounting to 3,636 GWh annually. The company is required to provide 10 percent of the energy produced (363 GWh) to Nepal free of cost under the project agreement signed with the government, which was renewed in October 2006. By exporting the rest, this project will earn US$ 158.9 million (at the rate of 4.865 US¢ per kWh) annually, which is equivalent to Rs 10.33 billion, or 15.5 percent of Nepal's trade deficit with India (not 25 percent). An in-depth analysis needs to be done to ascertain how much of the money will indeed percolate into Nepal's economy.

The project agreement authorizes West Seti Hydro to open accounts in foreign banks to deposit the export earnings. The revenue will thus not enter the Nepali economy in the first instance. Only the amount that absolutely needs to be remitted to Nepal will reach here. Therefore, the country's trade deficit will be lessened only to that extent, and only that amount can be called "hydro dollars".

Most of the export earnings will be spent on operation and maintenance, overheads, rates, taxes and royalties to the government and repayment of the principal and interest to lenders. The remaining will go to the equity holders as dividend. As hydropower is capital intensive, only about 2 percent of the export revenue will be expended on operations and maintenance of which less than one-fourth will be spent on salaries and wages. From the experience of the Khimti Project, we can assume that most of the high-salaried employees will be sourced from foreign countries while a few low-level staff will be hired locally. This means that only about 0.1 percent of the revenue will be distributed as salaries and wages in Nepal - about Rs 10 million.

Being a foreign direct investment project, the full amount of overhead expenses will be spent overseas. Moreover, the project agreement has waived income tax for the first 15 years, and the interest paid to the lenders and the dividend paid to the shareholders are not taxable. Therefore, West Seti Hydro will be paying a capacity royalty of Rs 100/kW and an energy royalty of 2 percent of the revenue during the first 15 years of its operation. It has to pay an export duty of 0.05 percent only. Hence, the government will be earning about Rs 287.9 million annually in royalties and taxes from the project.

Another major outlay is the repayment of a part of the principal and interest. As the project is borrowing from foreign agencies, these payments will never enter Nepal. The balance will be distributed as dividend. And since most of the project's equity comes from overseas - except for the government's 15% share - only 15 percent of the dividend will come to Nepal. However, as the government is borrowing from the ADB to invest in West Seti Hydro, even that 15 percent will disappear as interest.

Against this backdrop, only about Rs 297 million out of the total export revenue of Rs 10.33 billion will enter the Nepali economy. This comes to about 2.88 percent of the total export earnings. And by exporting electricity from this project, the country's Rs 66 billion trade deficit with India will be reduced by all of 0.45 percent. Thus the claim that this project alone will take care of 25 percent of the deficit is a myth.

Earning hundreds of billions
When politicos were canvassing for the Mahakali Treaty, they talked about Nepal earning hundreds of billions. They even liked to declare that the sun would rise from the west. A lot of water has flowed down the Mahakali during the last 10 years; but the sun is yet to change its habit, and Nepal is yet to receive even one percent of that fabulous amount. The contention of the Indian bureaucrat that Nepal would earn Rs 160 billion if it exported energy thus needs to be examined closely.

Projects aggregating 10,000 MW will generate 43,800 GWh of electricity, if designed at an average plant capacity factor of 50 percent. Using the West Seti format of 10 percent of the energy free for Nepal, one such project will export 39,420 GWh and earn Rs 124.65 billion. Superficially, at least, the gentleman seems to have been close to the truth.

Let's see how much of that money will actually enter Nepal. According to the West Seti system, only about 2 percent of the export revenue will be spent on operations and maintenance. Out of this amount, less than one-fourth will be expended on salaries and wages. The low-level Nepali staff will earn salaries amounting to about 0.1 percent of the export revenue, which is about Rs 125 million. The project too may be required to pay an export duty of 0.05 percent, that is, about Rs 3.55 billion into the government treasury annually.

Debt servicing is another major outlay. As these projects will be borrowing from overseas, Nepal will never see the full amount. The balance will be distributed as dividend, all of which will fly away to foreign shareholders as domestic investors don't have the clout to handle projects of this size. Doing some number crunching, we find that Nepal will get to keep only about Rs 3.68 billion out of the total export revenue of Rs 124.65 billion. This figure is about 2.95 percent of the country's total export earnings. Nepal's earning hundreds of billions by exporting electricity is thus as believable as the sun rising from the west.

(Published in The Kathmandu Post of January 9, 2008)

Friday, October 17, 2008

Clean up politics - and corruption elsewhere will wither away

If democracy does not stop corruption, corruption will stop democracy. As soon as the interim constitution is adopted and an interim government formed, another kind of transition will commence that will last till the constituent assembly is elected. After that a new constitution will lead to a popularly elected government taking charge.

A period as fluid as this is fraught with challenges, but also affords opportunity to design a future Nepal and decide its direction. How the future constitution is designed and structured will determine whether corruption can be eliminated so it doesn't destroy democracy. Politicians and bureaucrats brand businessmen as smugglers and profiteers. Businessmen call them crooks. Mom and pop NGOs have expanded this triangle into a quadrangle of corruption in which everyone benefits.

A party spending Rs 10,000 a month to maintain a single district office has to spend more than Rs 9 million a year in recurring expenses just to have a presence in 75 districts. Then there are elections. People fight elections not just to become parliamentarians but to become ministers so they can recover the investment made to win elections. If a candidate and his party jointly spend a modest Rs 300,000 in a campaign, multiply that by 205 constituencies and the total is Rs 61.5 million. Where are the candidates and political parties going to get that kind of money?

The answer: the business community intent on cashing in later, bureaucrats hoping for lucrative postings and NGOs wanting looser regulation. Whoever finances the politician will recover the investment with interest by means fair or foul. Nearly all other forms of corruption stems from that at a political level.

Therefore, if politicos desist from corrupt practices, corruption by the other three arms of the quadrangle will whither away, if not be eliminated all together. The following four measures need to be incorporated into the interim constitution and the one that the constituent assembly will eventually promulgate. Political parties aren't transparent and financially accountable at present, so first it should be mandatory for all political parties to publish each year's audited financial statements within three months of the fiscal year end. Parties failing to do so should not be allowed to field candidates for elections. Donations to political parties, within a limit, should be admissible as expenses for tax purposes. And one could even consider state funding for parties so they don't have to depend on businesses.

Political parties lead pro-democracy movements, but have no democracy within themselves. This engenders nepotism and favoritism, especially with dominant castes and families. The wrong elements corner important party positions, bolstering corruption. The new constitution should therefore make inclusive internal democracy in parties mandatory.

The most radical suggestion is the formation of an apolitical cabinet. Currently, the judiciary is independent from both the executive and legislature. However, people from the legislature populate the cabinet. Only the head of government should be elected by popular vote. He then puts together a technocrat cabinet from outside parliament, vetted by parliamentary hearing. This would stop politicos fighting elections with the express purpose of becoming ministers to make money. This will also stop ministers from nursing their constituencies while neglecting the rest of the country. Parliamentarians will also be able to concentrate on their legislative functions and monitoring the cabinet's work without being involved in the ministerial rat race.

Finally, the Auditor General's Office requires more teeth to transform it from being a mere watchdog into an organization able to stem corruption at its root by adding a treasury function. Parallels exist in India and the United States, where these bodies are empowered to stop disbursement to errant organizations. Such an institution is called the Comptroller General's Office in India and General Accounting Office in the US. Corruption will decrease substantially when these two policy changes and two institutional modifications are incorporated in the new constitution. Corrupt people may then be ostracized, and corruption treated with abhorrence, as it should be.

(Published as a guest column in Nepali Times of 11 - 17 Aug 2006, issue #310.)

Wednesday, October 15, 2008

Deconstructing Myths related to Hydropower II – Suggestions

A friend has said to me (verbally) that “only raising issues does not resolve the problem,” howsoever pertinent the issues are. That is absolutely correct. My excuse for not touching upon this facet in my previous write ups was simply the time the average readers are able to afford or inclined to devote. Besides, I launched this writing spree to ensure that a few errors in the presentations of some eminent personalities do not mislead the intellectuals, bureaucracy and policy makers. Since, his comment has provided me with an opportunity I will write a few paragraph in this respect but I will limit myself to the specific issues I have touched upon in my last write up, in the interest, again, of the time of the readers.

It’s Fresh Water, Not Energy
South Africa pays a lump sum of US $25 million (in 1991 prices) each year to Lesotho (surrounded by South Africa on all sides) for 18 cum/sec of water it receives from Lesotho Highlands Water Project. There is similar arrangement under Columbia Treaty between Canada and USA. For the sake of simplicity using the rate agreed between Lesotho and South Africa, Nepal is entitled to US $ 125 million per annum (equivalent to Rs 8.125 billion pa) from India for the augmented flow of 90 cum/sec from west seti project. To my mind it is as simple as what follows: if India doesn’t want to pay for the augmented flow then Nepal should not sacrifice 2,750 hectare of land to be submerged by the reservoir and 1,630 hectare permanently and 645 hectares partially of her land in Banke district to be inundated by the augmented flow, due to Lakshmanpur “barrage.” Columbia Treaty, too, clearly has provision to recompense Canada for her losing alternative uses of the submerged land, besides the recompense for flood control benefit. It is important to note that the project is going to rehabilitate people to be displaced by the reservoir which will amount to recompense of cultivated land that will be submerged by the reservoir but such land amounts to only 10%. There is no arrangement to recompense for non-cultivated land including forest.

What also needs to be remembered that building a reservoir not only provides augmented flow to the downstream area but also results in flood control for which too the beneficiary needs to recompense Nepal. Columbia treaty, further, recognizes power benefit due to building of the reservoir and she is entitled to one-half of the additional power generated due the reservoir. To draw a parallel here, the specific site of west seti project would have generated 100 MW without the reservoir. Therefore, Nepal is entitled to 325 MW (not meagerly 75 MW).

In this backdrop, therefore, agreements related to west seti needs to be revised accordingly.

India has never acknowledged downstream benefit and she equates free flowing water with stored water which is not one and the same. No one will pay a paisa for the water flowing in any river but the water will have economic (financial, as well) value after adding spatial or temporal utility for which purpose Nepal will be sacrificing, as mentioned above, 2,750 hectare submerged by the reservoir and 1,630 hectare permanently and 645 hectares partially in Banke district, inundated due to Lakshmanpur “barrage.”

Let’s look at Mahakali treaty in the above light. Nepal is entitled to 50% water from Mahakali River, deemed to be a border river. But, under current treaty India has been given additional 46.5% over and above 50% it is entitled to. Therefore, this treaty too needs to be revised incorporating provision under which India will be obligated to pay Nepal for any additional water over and above her share of 50% that India receives/uses from this river.

Export to and Import from India
People might have jumped to the conclusion that I am complaining about India is short changing us in this respect. I just hope that people will not be shocked, if I am to say that what is happening is natural phenomenon in this kind of market. From the perspective of export of power from Nepal to India we have a monopsony market condition and it is but natural that the importer enjoys “market power” and is able to dictate the price. Besides, in the power market it is also a fact of life that longer PPAs fetch lower prices while the shorter ones higher. West seti has a longer PPA term, and has been given lower price while, when Nepal imports power from India we do it for short term, and pay high price.

Having looked at the ground reality, Nepal should aim to maximize use of power generated by harnessing its water resource domestically and also benefit by forward linkaged benefits. Use it to lift water to irrigate, to run cold storage, to set up agro-processing industries, use for industrialization of Nepal, also to set up energy intensive industries. Nepal can escape from current petroleum product crisis significantly by electrifying transportation system (ranging from electric train, trolley bus, etc. to even hybrid car). As I said in my first write up Nepal’s objective should be to harness full economic potential of 43,000 MW for use by the population expected to reach 42 million in 2030 which will result in electricity consumption of 3,594 kWh per capita compared to more than 10,000 kWh of prosperous countries.

However, it does not mean that Nepal should, absolutely, be against export of electricity. What we should do is instead of dedicated power from Nepal’s water resource, Nepal should plan to export energy during wet seasons and off peak hours when it needs to spill her electricity generation capacity while during the same window of time the electricity demand in south is at its peak, thus commanding premium tariff for Nepal’s electricity. In this manner we could easily get out of the trap of long term PPAs.

In order to achieve above I recommend a mechanism under which Nepal should implement as many hydropower projects as possible with domestic investment so that investment linkaged benefit will stay in the country. This does not mean that we should close our doors to FDI. As long as the electricity is used for the benefit of the country who is investing in the project does not matter. My second recommendation is that Nepal should allow projects to be implemented by the investor/s (domestic or foreign) that will generate the electricity at the lowest cost. We should purchase all such power (at low cost) and electrify the nation massively (not just lighting a few bulbs in houses, though) and export the electricity that Nepal is not able to consume at premium price (I wonder if people are aware that India asked INR Rs 7 from a power plant in Tripura from Bangladesh). It should be obvious to all that Nepal may, for example, not be able to use full generation of west seti project for first few years, after that Nepal will be in a position to use close to half of it. In about a dozen years, Nepal will definitely be able to use all electricity generative by this project. I could go on with my recommendations but I think this much will suffice for now.

Decommissioning
In order to avoid having to make the tax payers of Nepal pay for decommissioning of west seti project, the better and prudent course is not to build it at all under present arrangement. However, if India is willing to recompense Nepal for (1) flood control, (2) augmented flow in the dry season and also (3) pay reasonable price for peak-in power, then we should allow it to be built on the condition that the developer company will set aside a certain portion of the cost of decommissioning and deposit it with GoN each year such that by the time the project is handed over GoN will have necessary fund to decommission it.

Nepal's Hydropower - Deconstructing a Few Myths II

Although, there is huge information as well has comprehension gap between fact and fiction about hydropower sub-sector of Nepal’s water resource sector, it is also clear that it will not be possible for the politicos to continue to take Nepali people for a ride in this matter. Every time Nepal passes through the transition (politically unstable) period Nepali politicos give away Nepal’s vital interests. 1950 treaty set the ball rolling on this path during the 20th century, merely to have Koshi, Gandaki and Mahakali Treaties (starting from Tanakpur “Understating” to Mahakali package) to follow in its wake. With the demise of “Panchayati democracy,” a new trend got underway entailing Nepal to surrender rivers to private sector in the name of export oriented projects. Examples of this new trend manifests in West Seti, Upper Karnali and Arun III projects.

It’s Fresh Water, Not Energy
One thing is common in all these treaties and agreements – ensuring fresh water for India. Without spelling it out explicitly, Nepal’s right to water in these rivers have been ceded. The issue in terms of downstream benefit in the case of reservoir projects is relatively easy to understand (some politicos refuse to understand the value of stored water while going about lamenting that water flowing in rivers, for which no one will be willing to pay a price without adding spatial or temporal value to it, is going awaste). West Seti project, for example, augments the dry season flow in the downstream areas in India by 90 m3/s, equivalent to 7.77 billion liters per day. In order to understand the value of such water one needs to know that Nepal is planning to invest in the order of Rs 30 billion to bring 170 million liters per day into Kathmandu. Had West Seti project been conceptualized as a multipurpose project, there would not have been an issue of downstream benefit to India. However, as there are no plans for Nepal to benefit from the augmented flow, India will receive such stored water free of cost, besides benefiting from flood control benefits. The issue here is why Nepal should inundate over 3,000 hectares of its land (to build the reservoir) and displace close to 20,000 people just to provide additional water to India during dry season, free of cost. Politicos and bureaucrats sermonize that Nepal is free to use such water while it flows within Nepal after exiting from the project. But without a multipurpose project being conceptualized for Nepal to use such water, India, after using the augmented flow during one season, will start asserting the principle of “existing prior consumptive use” and Nepal will lose the right over such bodies of water permanently. This principle has already been used in structuring Mahakali Treaty to the disadvantage of Nepal. This is one way of gifting precious fresh water produced by storing it in Nepal to India.

One will need to study Columbia Treaty under which Canada is compensated for losing alternative use of the land inundated and also for augmented flow in the dry season from USA, besides the power benefit shared between the two countries for constructing the reservoir project. Nepal should have insisted on using this treaty as a precedent in getting recompense for land mass lost due to submergence (including forest resources, wild life, existing infrastructure, etc.) in the case of West Seti project. Another way to get recompense for the augmented flow of 90 m3/s during the dry season is on the basis of the principle set by the agreement between Lesotho and South Africa under which the quantum of water is worth $ 83 million (equivalent to Rs 5.81 billion) annually.

Another way Nepal is ceding its right to water becomes apparent with some difficulty. Run of the river projects like Upper Karnali and Arun III do not generate augmented flow and, hence, apparently, no water related issues are involved. But an in depth study will make it clear that water issue is involved even in these projects. Section 20 of Electricity Regulation, 1993 guarantees “Right on Water Resources” which says that “The licensee, who has obtained license for production of electricity, shall have the right to use the water resources for the works as mentioned in the license to the extent of such place and quantity as specified in the license.” As stipulated by this section someone possessing a license to a specific site is guaranteed that no consumptive use of water will be undertaken in the upstream areas of the project, which might entail reduction of flow to the project site. By getting various “investors” to secure licenses to sites in Nepal, India has succeeded in ensuring that Nepal is forced to refrain from using the water for consumptive uses in these areas. In this manner too downstream flow to the Ganges is successfully secured with the issuance of each license and Nepal misses an opportunity to use such water, for example, to irrigate its arable land. In order to put things in proper perspective, one needs to remember that the Ganges receives 41% of its flow from Nepal in the wet season and 75% in the dry season.

On the other hand, although quite a few of Nepal’s hydrocracy (bureaucrats, intellectuals and politicos related to hydropower) believe that India badly needs electricity from Nepal, time has already proven that it’s not so. Take the example of West Seti. If India was badly in need of electricity from this project, Indians would have made sure that this project was built more than a decade ago. In other words, they would not have allowed this project to hibernate for one and a half decade. Same conclusion could be drawn from Mahakali Treaty as well. The detailed project report (DPR) for Pancheswar project was supposed to be ready within six months of execution of this treaty. It’s been over a decade now but the DPR is nowhere near sight. From this it could be easily seen that India is not that desperate for electricity from rivers in Nepal, as is being perceived (and also propagated) by Nepal’s hydrocracy. If indeed India was starving for electricity she could have easily ensured that Pancheswar project (6,480 MW from storage project and 240 MW from reregulating dam) is built and, probably, commissioned by now. By getting Nepal to sign on the dotted lines in the treaty document, India succeeded in legitimizing the use of water in excess of what she is entitled to (50% of the water in Mahakali – deemed to be a border River), which she had been illegitimately using prior to execution of the treaty. And it’s also not that difficult to see that she is in no hurry to get this project commissioned.

Export to and Import from India
Export to and import from India also succeeds in portraying the lopsidedness of the relationship between the two neighbours. The peak demand in last fiscal year, according to NEA’s latest report, was 720 MW. The industrial corridors in Butwal-Bhairahawa, Parwanipur-Birgunj, and Duhabi-Biratnagar are starving for energy for the existing industries. These corridors could use 200 MW each while establishment of new industries and expansion of the existing industries is constrained due to lack of electricity. Dr Amrit Nakarmi has figured out that merely to displace cooking gas (LPG, which is causing NOC to hemorrhage, besides other petroleum products) in Kathmandu valley we need additional 680 MW. By the time West Seti project gets commissioned in about 5 years, in this manner, Nepal’s own demand will exceed 2,000 MW. If Nepal is to try to be self reliant in the matter of energy for transportation and, therefore, electrify its transportation system (ranging from electric train, trolley bus, cable car to hybrid cars) the demand will be much higher. Therefore, it makes no sense for Nepal to endeavor to export electricity when she herself “doesn't have enough electricity”.

There is also fiscal tragedy inherent in this export-import “business.” It costs about Rs 21/kWh for NEA to generate peak-in power (from thermal plants) but peak-in power from West Seti project is slated to be exported at around Rs 3/kWh (US $ 0.0495/kWh) to PTC India Ltd. Further, Nepal is importing electricity from (the same) PTC at prices ranging from Rs 5.58 to Rs 6.50, for any time during the day and during all seasons, in 2006. After knowing this, it not only “sounds really stupid,” but it’s really stupid on the part of us (people in Nepal – for tolerating such a hydrocracy and the leadership all these years).

Decommissioning
There is unnecessary hype created by the hydrocracy about Nepal becoming rich after getting the project handed over after 30 years “free of cost”. As the old saying goes, it will be tantamount to us going about bragging that we have put on some weight while it was merely a case of swelling of the body. Besides, there is the issue of decommissioning which both the hydrocracy and the project people don’t like to talk. Although the main source of Kulekhani reservoir, for example, is not river based, the dead storage of this reservoir is already 25%. In other words, the capacity of Kulekhani reservoir has diminished to 75% of the original capacity in about 25 years. Seti River carries high silt load and West Seti project will transform into a run-of-the-river project from the reservoir project in about 30-40 years. At that time, after getting it handed over to Nepal, this project’s dam will have to be decommissioned. As the private sector has not provided any budget for this purpose, the government of Nepal will be forced to spend money for this purpose. Meaning, when Nepal is supposed to be “enjoying” electricity from this project handed over free of cost, she will be forced to shell out money for decommissioning which will be costlier than the origial project cost.

Monopsony
It is true that PTC is not the only buyer in India. However, existence of other buyers in India and PTC being authorized to be sole buyer of electricity from Nepal (thereby leading to monopsony market situation) is very different. Once other potential buyers also become authorized to play in this market the monopsony market with regard to export of electricity from Nepal will cease to exist.

Tuesday, October 14, 2008

Nepal's Hydropower - Deconstructing a Few Myths

1. Economic Potential in Excess of what could be consumed in Nepal
Nepal’s Water Resource Strategy[1] envisions that “by 2027, Nepal is exporting substantial amounts of electricity to earn national revenue”) but fails to specify the necessary installed capacity for the purpose. But one could easily visualize their train of thought by noting that the strategy stipulates that “by 2017, 2230 MW hydropower developed to meet projected demand of 2230 MW, including 400 MW for export.”

However, Professor Dr Ram Manohar Shrestha from AIT, in a series of his presentations, has stated that hydropower requirement for domestic market demand would be 23,000 MW in 2030 in order for Nepal to have per capita GDP in 2030 at the same level as that of Thailand in 2005. He has made an important point that has eluded the policy makers in Nepal, which is commendable.

He further postulates that Nepal could become rich by exporting the rest. I will revert back to the assumption that Nepal will benefit by exporting electricity. With regard to how much power Nepal can spare for export, people need to think outside the box and look at the issue from a different perspective. If Nepal’s economic potential of 43,000 MW is to be harnessed at the plant factor of 39.83% (as Professor Shrestha has used in his analysis), the electricity available will be 6,001 kWh per capita for the current population (25 million). With the population expected to reach 42 million in 2030, the electricity available will be a meager 3,594 kWh per capita. I am belaboring this point to link electricity consumption with the prosperity of a nation and its populace due to forward linkaged benefits like industrialization, employment generation, import substitution, etc. One needs to remember that most of the prosperous countries consume electricity above 10,000 kWh per capita (Iceland consuming the highest at 26,101.99 kWh per capita in 2007[2]) and for Nepali consumers to use 10,000 kWh per capita, the installed capacity necessary will be in the order of 120,000 MW which is a lot more than even the theoretical potential of Nepal. In this backdrop, it is disingenuous to say that Nepal has excess capacity. Therefore, people going about saying that Nepal has excess hydropower potential, the only use of which is exporting it to a neighboring country is misleading, at best, the uninitiated general public.

Instead of dedicated power from Nepal’s water resource, Nepal should plan to export energy during wet seasons and off peak hours when she is forced to spill her electricity generation capacity while during the same window of time the electricity demand in the south is at its peak, thus commanding premium tariff for Nepal’s electricity.

2. Mythical Hydro Dollars
A number of luminaries have been going about saying that Nepal can become rich by exporting electricity. Dr Shankar Sharma, former vice chair of National Planning Commission, has been quoted as saying that Nepal can earn a revenue of Rs 25,000 crore (a crore is 10 million) as such from 10,000 MW project implemented with Indian investment. While Mr. T N Thakur of PTC India Ltd. has been credited to have said that Nepal can earn INR 10,000 crore (at another time he said US $ 2,700 million) from the export 10,000 MW electricity. But detailed calculations behind these numbers are not available.Professor Shrestha, in his presentation, has prepared a bar chart showing “How big could be the Potential Hydro Revenue” based on following data:

Hydropower capacity MW Million USD
5000 MW $1,476
10000 MW $2,953
20000 MW $5,906
30000 MW $8,859

He says that Nepal’s incremental revenue will reach these levels with the implementation of hydropower projects at various capacity levels. With him coming up with USD 2.953 million that he expects Nepal to earn by exporting 10,000 MW, he is pretty close to Mr. Thakur’s estimate. A close look behind these numbers will help us deconstruct this myth too.

Professor Shrestha has used the tariff rate of Rs 5.41647 per kWh (equivalent to US $ 0.08463 at Rs 64/USD) which is way too high. Because, West Seti Hydro Ltd., for example, is slated to get only US $ 0.0495/kWh under the agreement it signed with PTC India Ltd. West Seti project generates peaking energy fetching higher tariff and, obviously, energy generated by the run of the river project will fetch a rate lower than this level. Therefore, the effective average tariff for export of energy to India will have to be substantially lower than US $ 0.0495/kWh. In view of this the above “Potential Hydro Revenue” computation is an act of overestimation based on unrealistically high tariff.

Secondly, but more importantly, people have also taken for granted that whatever an export oriented project earns by exporting electricity from Nepal will be the “hydro revenue” for Nepal. This inference is based on the presumption that Nepal will receive full proceeds of the export revenue as her own revenue and it will percolate into Nepali economy. In real life things don’t happen like that.

It must be remembered that, of the total export earning, the only amount that absolutely needs to be remitted to Nepal will reach here. Most of the export earnings will be spent on operation and maintenance, overheads, rates, taxes and royalties to the government and repayment of the principal and interest to lenders. The remaining will go to the equity holders as dividend. As hydropower is capital intensive, only about 2 percent of the export revenue will be expended on operations and maintenance of which less than one-fourth will be spent on salaries and wages. From the experience of the Khimti Project, we can assume that most of the high-salaried employees will be sourced from foreign countries while a few low-level staff will be hired locally. This means only about 0.1 percent of the revenue will be distributed as salaries and wages in Nepal.

The investment to implement projects of this scale will have to come from abroad due to the dearth of fund in Nepal – both debt and equity. Being a foreign direct investment project, the full amount of overhead expenses will be spent overseas. Moreover, FDI will not be too eager to come to Nepal if there is no income tax exemption. Therefore, these projects will be paying only capacity royalty of Rs 100/kW and energy royalty of 2 percent of the revenue during the first 15 years of its operation and Rs 1,000 per kW and 10% of revenue respectively afterwards. In conformity with the precedent set for West Seti project, these projects will be paying an export duty of 0.05 percent only. Hence, the government will be earning about 2.72% of the export revenue annually in royalties and taxes from the project.

As agreed above these projects will be borrowing from foreign financial intermediaries, the proceeds of debt service will not stay in Nepal. The balance will be distributed as dividend. And since most of the project's equity will come from overseas, the dividend will also flow there. Therefore, of the total export earning of the specific project companies, only 2.82% of it will enter Nepal’s economy. Again following the precedent set by West Seti project, the export oriented projects may give some free energy to Nepal, in which case Nepal’s revenue will go up by that amount. Therefore, in no case total value of the exported energy will become the revenue of Nepal. Specifically in the case of West Seti project, Nepal’s revenue will be about 12.82% of the project’s revenue (including free energy of 10%) and Nepal in no way will receive 100% of the project company’s export earning.

3. Nepal can become rich by earning royalties
Professor Shrestha also compares earning from tourism with potential economic rent of hydropower for which purpose he has used the rate of royalty at US 1.5 ¢/kWh and has came up with following results:

Hydropower capacity MW Royalty, million US $ @1.5 ¢/kWh
5000 MW $262
10000 MW $523
20000 MW $1,047
30000 MW $1,570

I agree with him that “At a given market price of electricity, per unit hydro rent (or royalty) would be higher in the case of the low generation cost projects (“more attractive” projects)” compared to high generation cost project. But, unfortunately for Nepal, this sound principle is not followed and, to borrow words from him, at “present hydropower royalty seems to be an ad hoc policy not based on the principle of economic efficiency.”

Under current ad hoc policy (enforced mainly on the basis of Electricity Act, 1992), the applicable royalty rates are as specified above. The effective royalty for first 15 years works out to a rate between 2.4% to 2.7% and around 14% to 16% afterwards. In view of this there is no way for Nepal to earn royalty from hydropower projects at the rate of US 1.5 ¢/kWh as the electricity is exported at a tariff less than US 6 ¢ per kWh (in which case the royalty rate will be US 0.15¢ only). Even at the higher tariff rate of US $ 0.08463 per kWh, that Professor Shrestha has assumed, the royalty income for Nepal will be at the rate of US 0.21 ¢ per kWh only.

To look at the issue from another perspective, projects in Nepal will have to export electricity at US $ 0.60/kWh in order for it to earn royalty at the rate of US 1.5 ¢ per kWh during first 15 years of operation which is highly unlikely, given the current market situation.
[1] Water and Energy Commission Secretariat, GoN, 2002
[2] Source: http://www.nationmaster.com/index.php