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


Unknown said...

Good analytical

L B Thapa said...

Dear Mr. Ratna Sanasar Shrestha FCA,
Happy Tihar,Nhu Daya Vintuna and chhath,
Go ahead to make Nepalese hydrogen economy to boom. SPAM are not trailblager to the nation. Smuggling Indian oil selling at highest price while lowering 300% in international oil market price made a lot of profit upto their seventh generation proves from promotion of Sujata to deputy prime minister.

I'm not sure whether Pradip Nepal's email that 15th provinces submitted by UML is not an offical decision. What was the stand of UML on MAHAKALI treaty every ones knows. UML was bifurcated in the name of Mahakali treaty , Bamdev Gautam is still alive and CP mainali too.

We wish you to interven to SPAM on water resources sectors and give your opinion constantly against feeble and "MASK" idea of these so called "BIG parties".
We are with you to spread your beautiful ideas based on emperical research/study.
Thank you,