Thursday, November 13, 2008

"BPC is a risky venture"

Ratna Sansar Shrestha is senior adviser of Winrock International’s Clean Energy Group, an INGO, which is providing, what it calls, "hand holdings" services to the private sector companies of Nepal to develop power projects. A Chartered Accountant (an FCA) and a corporate lawyer by training and profession, Shrestha, however, has a long exposure in hydropower (including that of being the DGM in Khimti Project), and contributes articles to international journals about the power sector, thus is regarded as an expert, in Nepal’s power sector, though he does not like to be identified by that adage.

Soon after the financial bids for the privatization of Butwal Power Company Ltd. (BPC), the first infrastructure sector company HMG put forward for privatization, were opened, New Business Age interviewed him about this perhaps the most controversial case so far in Nepal’s privatization drive. Excerpts:

How do you see the controversies that have been surfacing after the latest bids were opened for privatization of BPC?
Chaudhary Group got disqualified and, therefore, they want to create controversy in order to have the process cancelled once more. Their financial bid was returned to them unopened, but they opened it themselves and faxed the copy to all the newspapers, which, in turn, reported that the value of Chaudhary Group’s bid was Rs. 820 million rupees. Comparing that with Interkraft’s bid amount of Rs. 730 million rupees, people were jumping to the conclusion that Chaudhary Group’s bid was worth Rs. 90 million higher and, therefore, His Majesty’s Government lost an opportunity to get Rs. 90 million extra. But in this case, you have to be very careful. Chaudhary Group was planning to pay only 70% of its bid amount in the first year with the rest 30% to be paid in the second and third year. If their bid had been accepted, they would have paid Rs. 574 million in the first year and Rs. 123 million in each of the second and third year. Whereas, Interkraft has proposed to pay the full amount of Rs. 730 million in the first year itself. After evaluating both of the proposals in terms of present value (entailing computation of present value by using the discounting factor of 8% in dollar terms, as has been the condition of the Finance Ministry), you find that Chaudhary Group’s offer was only Rs. 30 million higher than that of Interkraft. That is insignificant. Everybody knows that Chaudhary Group’s offer was rejected primarily on the grounds of procedures and administrative rules, besides the fact that they lacked any experience whatsoever in hydropower generation, transmission and distribution which is mandatory under bid documents (at least 30 MW).

What actually is wrong with Nepal’s privatization process that it took so long for BPCs privatization?
You better ask the government about that. You know in Nepal everything moves so slowly. On top of that there was the pressure from the diplomatic missions. The Charge d’ Affaires of US Embassy went out of her way and wrote an official letter to Finance Ministry claiming that IPC’s bid is better and, therefore, should be selected in the second round of bidding. And it was also reported in the newspapers. At that time Interkraft made an unconditional offer of Rs 115 per share while IPC offered Rs 109 per share, 90 percent payable in seven years.

Being a CA yourself, how do you react to the contention that the Rs. 116 or so offered by Interkraft for BPC is ridiculously low given the fact that the Rs. 100 per share invested in the company was about four decades ago?
You must remember the going concern concept. HMG is selling the shares of BPC as a going concern. So the value of BPC shares is determined by the present value of future streams of revenue that it will be able to earn. At the moment BPC has a PPA for just two years. After that they have no customer to whom to sell their product – with only one buyer of electricity in Nepal we have monopsony situation prevailing. Conversely, if BPC had PPA for 10 years, they would have a guaranteed revenue stream for 10 years, and the shares of BPC would have been worth lot more than Rs. 116. Additionally, compare that with Khimti and Bhote Koshi tariff. Their PPA is for more than Rs. 5 per kWh while Arun Valley project, in which only Nepali investors are involved, have signed the PPA for about Rs. 4 per unit. Whereas, BPC is given less than Rs. 3. And there is no certainty that the PPA will be renewed. As soon as Kali Gandaki ‘A’ goes on stream, NEA will be ‘spilling’ electricity to the extent of 40% of total production. And Khimti as well as Bhote Koshi have firm (take or pay) PPAs. In that scenario, it is quite unlikely that NEA will even renew the PPA with BPC. So, investing in BPC is a quite risky venture.

Now it is most likely that BPC will be handed over to Interkraft and its Nepali partners. As you were once a consultant to that group, would you please shed light on their plans for BPC?
I am working for Winrock International, which was a consultant for the group, but no more. From that perspective I may know some things about them. They have submitted a very well thought out business plan, with necessary foresight and vision, to the government and that is one of the reasons why they got technically qualified. But at this moment, it would not be appropriate for me to divulge you the details. I can tell you about the business of BPC. They run the power plants they have and sell the power to NEA they generate. It also sells power to the general public in a number of districts like, Syangja, Palpa, etc. and they are serving the customers better in these areas with relatively better record in technical loss and payment default. They develop new hydropower projects and provide the engineering services much needed for hydropower sector. They have a separate engineering division for this purpose. BPC is the only company in Nepal that provides all the services, throughout the project cycle: conducting feasibility study for hydropower plants, designing hydropower plants and helping in building hydropower plants to the point of actually generating electricity.

As an expert in hydropower sector, how do you see the controversies regarding the private sector’s involvement in other power projects and the power purchase agreements (PPAs) they have with NEA?
I don’t consider myself as an expert in hydropower. I happen to know little bit about it as I’ve been working in this sector for last 15 or 20 years. I am not an engineer. I don’t have insight of how the turbines and generators work. But I know the business side because I am a management professional who also happens to be a chartered accountant and a corporate lawyer. Nowadays, people think as if the whole problem is linked to privatization. I do not subscribe to this idea. The PPA with Khimti was signed when I was the deputy general manager in Khimti. So I was a witness to it. What you have to remember is that Khimti is a pioneering project in the history of Nepal’s power sector. Before Khimti, NEA constructed all the hydropower projects with multilateral grants, aid and so-called soft loans. With the demise of Arun, Khimti became the obvious choice to get over the reigning problem at that time of blackouts and load shedding. Arun was a 201-MW project estimated to cost US$ 1 billion. That would have meant US$ 5,000 per kilowatt (kW) of installed capacity. But you know, none of the public sector projects in Nepal have been completed within the budget - both cost and time. There is always cost overrun and time overrun. Marsyangdi cost NEA about US$ 3,000 or 3,500 per kW. Kali Gandaki, they initially said, would cost US$ 2,000 or so. But now it is going to cost more than US$ 4,000. So you can easily imagine that Arun would have pulled the tariff considerably up even without any cost overrun. Compare that with Khimti, which cost US$ 2,300 only per kW. Khimti not only costs less, it also proved to the world that, in fact, infrastructure project like hydropower is possible in private sector in Nepal. If you are dependent on foreign aid and grant, you will develop the dependency syndrome. At the end of the day when the aid dries out, you wouldn’t have any new project. For Arun, the World Bank was going to give soft loan at the interest rate of 1.5% or like that. But we must not forget the hard part of soft loan. Suppose one million dollar as soft loan is received by HMG/N in 1980. At that time it was worth Rs. 11 million because the exchange rate was about Rs. 11 for a dollar. Now it is Rs. 75. So, for the principal amount of US$ 1 million in 1980 handed over to the NEA in rupees, HMG will be paid back only 11 million rupees as the principal. But today the government has to pay back just as principal Rs. 75 million to the lender. So this soft loan is in fact not soft. Therefore, a hydropower project based on even a soft loan is not sustainable. Where does the government bring the additional money to pay the loan? What Nepal Electricity Authority (NEA) collects is by way of tariff, which comes from the consumer. But when the government has to fill the gap, it has to raise the tax, which is collected even from those who may not have any access to any form of electricity. Suppose NEA did not increase the tariff what would have happened to NEA? It would have made a loss. That again would have to be subsidized by the government through taxes collected from all the people – even those without electricity.

With these experiences, how do you see the future of private sector power projects in Nepal?
I see it to be very bright. But as long as we depend too much on foreign money, we will be doomed because of our fast depreciating currency. The solution lies in using local capital, local skill and local labour. If you bring the foreign skill, they talk in terms of US$ 300 per hour. You know the result of bringing in foreign capital. Khimti and Bhote Koshi are good examples. You are aware of the fact that Nepal at present has a very high liquidity. That liquidity can be used for the development of hydropower. I would like to add here that in fact our organization Winrock International is now assisting in establishing a dedicated bank called Clean Energy and Infrastructure Development Bank with paid up capital of Rs. 500 million. The promoters have subscribed 60% of that and there was overwhelming response for it. This bank will address the market failure as is being experienced at the moment. If you have a lot of money and go to a bank to deposit it for a long term, no bank will accept it. If any one of them does, it will be as if it is doing you a favour and it will offer you an interest rate of 6% at the most for long-term deposit. On the other hand, if you are developing a hydropower project, and go to these banks and ask for the loan, they say, "no, we can’t give you a long term loan". The market has failed to match both the demand and supply. This new bank will address that problem. It will not only accept long-term deposit at reasonable interest rate but also provide long-term loan. That way, it will develop Nepal’s hydropower sector on the one hand, and on the other, it will use Nepal’s excess liquidity. Moreover, this bank will also finance other energy intensive industries and projects. Tea processing being an example of the first type while trolley bus on the ring road being the other example.

Is not that much of paid up capital too small looking at what you said the new bank is going to concentrate in?
A hydropower project normally needs about Rs. 100 million per MW, if it is implemented at a reasonable cost, without any cost overrun. After having worked in this sector for a while, I think the ideal size for Nepal is between 3 to 5 MW only. If we are doing a project with Nepali capital, Nepali labor and Nepali skills, then we should do a number of projects but within 3-5 MW range. For small projects you don’t need fancy lawyers, fancy engineers, foreign consultants, and foreign contractors. The example is Chilime. Though it is a bigger project - of 20 MW - it is done with local resources. That is the path we should move forward.

Is there any way to reduce the cost of Khimti and Bhote Koshi?
I think that can be done without giving trouble to the investors. Khimti has US$ 100 millions as loan from a number of foreign banks. If we can raise that amount of money locally and repay the dollar loan, then Khimti’s price will go down by 25%. Conversely, if we wait, Khimti’s tariff in 2016 will cost NEA Rs. 42 whereas Chilime’s will cost only Rs. 12. In order to avoid that situation, we should repay the dollar loan in both Khimti and Bhote Koshi if we can get our act together.

What is blocking the implementation of this idea, as it has already been some time that it is floating around?
The problem is for someone to start talking with the lenders like ADB and IFC. My article about it was printed in Deshantar and that was discussed in the Finance Committee of the parliament. The present finance minister liked the idea and he also came out with a newspaper article about it. So it is only a matter of will power. Still I wouldn’t call it a total solution; it is only a partial solution. But again, you must remember that the lenders wouldn’t like to accept the prepayment of their loans. More so in case of Khimti, because Khimti loans are costlier, even when compared to Bhote Koshi. In Khimti, IFC is charging 11.48% for its senior loan in dollars and 13.74% for the second loan. Similarly, ADB is charging 10.5% for the senior loan and 13.74 for junior loan. Whereas, in Bhote Koshi, the rate is about 8% only. So the lenders also will not be too happy to be paid back prematurely. But we can convince them. If ADB, for example, agrees to replace its dollar loan by rupee loan that would be better.

How do you see the prospects for Nepali private sector investment flowing into the development of hydropower?
Well, this is an entirely new area for them. Our Nepali private sector has a herd mentality. When somebody builds a hotel, everybody starts building hotels. When somebody starts a noodle factory, so does everybody else. But hydropower has not been like that as yet. Besides that, if you talk about all the so-called industrialists, the net worth of most of them may not exceed 100 or 200 million rupees. But hydropower, even when you talk about just 3 MW, it will cost not less then Rs. 300 million. It is very capital intensive. Initial investment is very high.

Besides investment what are other hindrance in hydropower development in the country?
The net worth of the businesspeople in Nepal is very low. They have taken too much loan leveraging too many times. You may see them driving Benzes and BMWs. But all of that comes either from RBB or NBL. It may sound too bitter but that is a fact. The second part is, even if they have enough to put in as equity, naturally none of the private sector will be willing to put up a 100% equity in a project, because that does not make a business sense. So, they need loan. As I said earlier, in Nepal there is a market failure. The banks are not well equipped to invest in hydropower, though I should also inform you that, and happily I do so, there recently was a consortium of seven banks which is financing about Rs. 190 - 200 million to a hydropower project - 3-MW Arun Valley. So there are investors now.

What was the role of your organization (Winrock) in this?
When we started this organization we wanted to encourage private sector to go into hydropower. But the so called established business houses did not want to take the risk. Arun Valley is started by professionals like economists, engineers, and hydrologists. We helped by way of providing risk-sharing mechanism. In hydropower, there is no guarantee that each site will be equally feasible. We shared half of the cost of the feasibility study. At the end of the day, if the project becomes infeasible, the developer loses the half, we lose the other half.

But if the project becomes feasible, then the company pays us back at the time of financial closure. So we have invested in nine projects in the pipeline now for which feasibility studies have been conducted. And there are other dozen projects in which we are providing technical assistance. Out of them, construction has already started in Piluwa Khola project in Sankhuwasabha district. One encouraging thing about this project is that now their estimated cost is $ 1,300 per kW. You can compare that with NEA’s figure. Say, there is a cost overrun of 10%. Even then, it will be very manageable compared with Kaligandaki’s $ 4,000 or Marsyangdi’s $ 3,500 per kW.

Do you mean to say that we don’t need large-scale power projects?
If you look at the growth rate of power demand in Nepal, it is between 8 to 10%. Our system capacity is about 400 MW. That means if we can make 10 projects of 3MW every year, it is enough. If we are able to manage capital, labour and skill locally, and if we have 10 projects in the pipeline every year, we don’t need any large project.

Will you please give some explanation about this projection of 8% growth rate, as there also is suppressed demand?
I was talking about the normal growth. In the electricity sector we always talk about 85% of the populace who are in the dark. If you take the ambition of providing electricity to all of them, the growth has to be 600%, and we simply cannot achieve that. When you talk about extending the transmission line, again you are talking in terms of investment. Businessmen wouldn’t like to go into that. They rather like generating electricity and selling it to the grid in bulk.

There are also suggestions coming up for distribution part only to be privatized and NEA remaining the wholesaler. What is year comment about it?
I remember Honourable Dr. Roop Jyoti saying exactly that in the upper house of the parliament. I applaud him. But if you talk to the private businessmen here, they may not be too willing to come forward for this line of business. Because in distribution sector you have to face technical loss, and there is also the payment default. Compare that to the situation in which Khimti and Bhote Koshi are i.e. selling bulk energy and being paid by NEA with a single cheque every month. Of course, private sector could better manage the distribution and payment, but I doubt whether they will really be interested. Coming to Interkraft, let me inform you that they are in fact planning to go for distribution as well. Even now, BPC is doing local distribution in some areas with power generated from Andhikhola and Jhimruk projects.

What about the argument that private monopoly would be better then NEA monopoly, given the track record of NEA?
I don’t like NEA monopoly, or any monopoly for that matter.

Which would be the better one among these two worse alternatives-NEA monopoly and private monopoly?
We also need to remember that in power sector we can’t have prefect competition. Still, the world has gone a little forward. To take an example from Norway, there are a number of companies generating electricity, and there are a number of companies distributing electricity and there is a network of transmission and distribution lines. If I’m buying power from one company today, I can change the supplier tomorrow, based on the price they offer. I can do exactly the same with telephone in USA. That may not be possible right now in Nepal as that needs appropriate switching system, billing system etc. and bringing such systems may still take some time.

Those raising voices against private sector coming into power sector put forward the example of California fiasco. What do you say?
In the first place, we will not reach the California situation till another 100 years. What actually failed there were the system planning and the load forecast.

With the new prime minister being known to favor big power plants, how do you foresee this big and small power plant controversy going ahead?
Let me ask a counter questions: why would you need big plant when you can’t consume all the power it generates? People who argue in favour of big hydropower plants are talking in terms of export of power to India. They say, rather than wasting the water, let’s generate power and export. They seem to sound right, but I don’t accept that idea either. Today, the population of Nepal is 23 million and the economic potential in hydroelectricity generating is about 40,000 MW. That gives a per capita power allocation of 2 kW. On top of that, we surely can’t reach the generating capacity of 40,000 MW within five years, it may take 30 years. By then the population is projected to almost double. That means, the per capita power allocation will then be 1 kW. In developed/prosperous countries, the norm is about 10 kW per capita. I don’t agree with the contention that we’ve excess capacity in hydropower.

Inverviewd published in September 2001 issue of New Business Age

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