Thursday, November 20, 2008

West Seti project and “One Sided” Perspective

A reader, who claims to have read my paper titled “West Seti Project – a Nepali Perspective” has sent me an email saying that (1) the “paper is one sided (completely ignored positive side of the project) and (2) is preventing the country's hydro power development (3) which will ultimately hamper economic development and (4) social upliftment of the country.” His taking the initiative to comment is appreciable and affords us an opportunity to continue with the dialogue and also continue the engagement process. This process will help Nepali people get to the heart of the matter. Because, the subject matter isn’t too easy to understand (even a highly educated person like him didn’t understand it – or rather I failed to make it clear to him in my first attempt) and it will not be surprising if some other people too take a little longer to understand (there already is a critical mass of intelligentsia who have understood the “perspective” and have expressed their solidarity with me.

1) One Sided Paper
1.1) First of all, without feeling even a bit of embarrassment, I will confess that I am indeed a one sided person in this respect and the objective is to secure the interest of my motherland (hope this does not come as a surprise to people like him!). I am rather proud to be one sided as such. I know of many people in Nepal who will not tire of proclaiming their patriotism and say that they are working for the best interest of Nepal and people in Nepal but use every opportunity to betray the nation and the people no end. Just looking at the water resource sector – from Koshi through Mahakali treaties and the barrages/embankments that India has built near the border against the international law – one can easily draw this conclusion. These people misinterpreted and took out of context various national and international laws, treaties, conventions, precedents and practices to give away what is rightfully due to Nepal – all in the name of “best interest of Nepal and people in Nepal.”

However, I am not misinterpreting and taking out of context any national and international law, treaty, convention, precedent or practice as they are doing. I am merely doing my best to use/interpret national and international laws, treaties, conventions, precedents and practices in a manner such that Nepal will benefit; she will get what is due to her. I know (I am sure everyone knows) that that is what a person will do in order to secure his/her own property (actually in the matter of personal property some even go overboard in interpreting laws to ensure that they get more or get to keep more). However, I am not going about misinterpreting and taking out of context various national and international laws, treaties, conventions, precedents and practices, for that purpose. I am merely endeavoring to secure what rightfully belongs to Nepal. I don’t see anything wrong in this. To me going the other way – surrendering Nepal’s interest to serve the interest of the neighbor – is the betrayal of this nation (irrespective of whether done as such for personal gain or no such gain). I am unable to stand idly by while people are doing this.

I also think it is better to be one sided like me (to me, absolutely normal behavior) than the other extreme of one sidedness – there is no dearth of such people in Nepal – who announce their love for Nepal, euphemistically from the rooftop, while working to harm her interest.

Someone even called me a biased person. In my considered opinion it is no crime to be biased in favor of one’s motherland. I would like to compliment Indian people who don’t, generally, betray their motherland as such. I have found them working really hard to ensure the interest of their motherland in every possible way. I will give one example. In a map portraying Koshi flood, India Today, a popular and established magazine, published in the week of September 8, 2008, included Nepal’s Terai in Indian Territory. I don’t believe in doing as such, and my endeavor is not to “cheat” India of what rightfully belongs to her. I am merely striving to make sure that Nepal gets what she deserves.

1.2) This person seem to have jumped to such a conclusion about me because, in his words, I have “completely ignored positive side of the project.” However he didn’t cite any example to substantiate the allegation. Looks like he had to make this comment for some – explicable or inexplicable – reason but was unable to find any basis to justify his own allegation.

Having studied the presentation made by Mr. Bill Bultitude, Managing Director of West Seti Hydro Ltd., it is clear to me, that I have not ignored any positive side of the project in my assessment. He talks about “BOOT structure – asset transferred free of charge to GoN at the end of the license period.” In my paper I haven’t ignored this “benefit”. My only disagreement is with the unnecessary hype (which could mislead uninformed people) created about it in terms of “assets worth $ 1.2 billion.” I have merely proved that when this asset will be transferred to Nepal, it won’t be worth this much – neither in terms of present value, nor depreciated value or even practical value. On the contrary there is the issue of decommissioning which the project people, and both hydrocracy and donorcracy (bureaucrats of donors) have not only ignored but have failed to be transparent in this respect. I am glad this issue is now out in the open.

In listing “benefits to Nepal – the people” Mr. Bultitude talks of “creation of up to 3,000 jobs during 5.5-year construction period. However, in assessing the backward linkage I have used 5,000 jobs – a clear case of over estimation on my part. I am sure that this definitely doesn’t amount to my ignoring “positive side of the project.”

In the list of benefits Mr. Bultitude also includes “direct injection of funds by GoN into the Project Area Districts.” But this definitely is not a benefit that the people of Nepal derive from the project. Then he talks of training and skills development program, Nepali contractors getting work, development of infrastructure in the area, 8 MW power station for sale of energy for local consumption, 4% equity to be reserved for the local residences, direct employment opportunities, spin-off benefits, technology transfer, training, etc. It should not be too difficult to understand that the thrust of my paper is that there are better alternative approaches for the implementation of this project which will serve Nepal’s interest better (you will recall that, in my recommendation, I have suggested two models). As all the benefits Mr. Bultitude refers to will also accrue to Nepal even if one of my models is adopted, these “positive sides” are not special to the way this project is being envisaged to be implemented and neither have I ignored these benefits.

Mr Bultitude also goes on to list benefits from royalties. I definitely haven’t ignored this benefit. Under the heading of “fiscal linkage” I have taken this into account which, in my reckoning, is worth $ 4.4 million (about Rs 330 million) per year. It is clear that that this benefit will too be reaped by Nepal irrespective of whether the project is implemented as I have recommended or people succeed to implement it under which Nepal, in my opinion, gets short changed of revenue streams that she is rightfully entitled to, like recompenses for flood control in wet season, augmented flow in dry season, and carbon offset.

Moreover, in order to build a reservoir project, Nepal is required to sacrifice its land – 3,004 ha under the reservoir in this case. But projects without a reservoir are paying 7.5% energy royalty and Rs 400 per kW as capacity royalty (on top of 27% free equity in the case of upper Karnali project). In view of this the positive benefit from the West Seti project is definitely on the lower side substantially. Similarly in the case of free energy these projects are providing 12% and 21.9% (by Upper Karnali and Arun III respectively) compared to 10% from this project. In this backdrop the project’s positive side is severely on the lower side because, for this project Nepal, it seems, is getting her land submerged (hence sacrificing) for nothing. As the magnitude of positive benefit is much lower, it is incumbent on a person like me to question it. In this respect too, it is clear that I didn’t ignore the positive side, but merely pointed out that with better structuring Nepal could have received royalties and free energy at a higher level.

I am sure that people know about the tariff at which NEA imports energy and purchases from domestic Run of River projects and the tariff at which electricity from this project is planned to be exported. A project generating peak-in energy (which is not possible without submerging Nepali land) is planned to be sold at dirt cheap tariff. It is also clear that the quantum of benefit from royalties to Nepal would have been much higher if the tariff was fixed at a reasonable level. Looks like the project people would have preferred that I didn’t raise these questions, notwithstanding all these. Since I have already raised it, I am one sided in their eyes. Too bad!

2) “Preventing the Country's Hydro Power Development.”
2.1) I wonder how my raising a few questions as such could prevent country’s hydropower development. These people are making me feel really important. I doubt if my raising a few questions like these will stop the work as I am not an important person that people need to pay heed to. For me it’s just like “emperor’s new clothes” – when I see that the emperor (hydropower development) is actually not wearing any clothes – forget the fabled new clothes.

2.2) I wonder what kind of hydropower development people like him are referring to. In the way the project is structured, people will be soon become disenchanted/disheartened – once they start to understand – and begin saying that it’s better to not have hydropower development than have Nepal short changed on every pretext, at every opportunity. I have proved that even neglecting the downstream benefits, by better packaging of royalty and free energy Nepal could have benefited at a higher level than what SMEC is promising.

Since he wanted to talk about hydropower development, I wish that people like him were able to analyze the benefit of forward linkage due to use of electricity in Nepal to the macro economy, rather than exporting it. At the moment Nepal is suffering from energy famine and by the time the project will be commissioned Nepal will be in a position to use much of the electricity produced by it. But it will be going to India at dirt cheap tariff and Nepal will be forced to continue to import from India at double the tariff or resort to load shedding. This isn’t a prudent model of development of hydropower. The positives of using electricity in the industrialization of the country which will generate employment at higher level and its consequential positive impact on the economy are higher by a magnitude than by exporting it at dirt cheap tariff.

2.3 The model of hydropower development these people are partisan to also will develop Nepal’s hydropower but imagine at what cost. Nepal is required to relinquish its rights over augmented flow worth Rs 5.8 billion per annum and carbon offset benefit worth Rs 1.5 billion per annum, in total Rs 7 billion per year even without reckoning for flood control benefit. Properly/correctly structured the project can generate the amount the project people are saying – the correct amount, though – and additionally Rs 7 billion annually. I hope this isn’t too difficult for people to understand.

3) “Ultimately Hamper Economic Development”
People like him seem to believe that raising questions as such will hamper economic development. On the contrary the wrong model of what is called hydropower development will hamper the economic development of Nepal – export peak-in energy at dirt cheap tariff, receive royalties at very low rates and the lowest possible free energy, and, most importantly, sacrifice downstream benefits (worth Rs 5.8 billion per annum) and carbon offset benefit (worth Rs 1.5 billion). I doubt that for such a small economy like ours sacrificing over Rs 7 billion (at current price) each year will lead to economic development. All the developed and prosperous countries are where they are today because its people ensured that their country got almost all of what they deserved, not because they gave up what they were rightfully entitled to, in the name of ensuring best interest of their motherland.

Economic development of Nepal requires mobilization of huge amount of fund and giving up Rs 7 billion annually – which is not petty cash, even for rich countries – deprives Nepal of the much needed cash. Therefore, nobody has right to give up such an amount in the name of “economic development.” Well, some people – much pampered by the state that they are – may think that such amount could be given up. But most of the people, who have yet to see any semblance of economic development, need that kind of fund to undertake development work and Nepali people need to work hard to ensure that Nepal is not deprived of such amounts.

4) Hamper Social Upliftment of the Country.
It was also alleged that my approach will hamper social upliftment of the country. But I fail to see what kind of social upliftment the likes of him talking of when Nepal is getting short changed at every opportunity, on various pretexts.

Hence, one sided people, without being able to substantiate it, who call me one sided are just venting their frustration. Such frustration may have emanated from the fact that although they, proclaiming to be patriots, say that they are working in the interest of Nepal and people in Nepal, also know at their heart that their actions might have short changed Nepal of what rightfully belongs to her (probably a case of guilty conscience). It probably does not sit too easily on their conscience for having been involved in interpreting national and international law, treaties, conventions, practices such that it ends up benefiting a foreign country rather than Nepal.

Sunday, November 16, 2008

West Seti Project - a Nepali Perspective

West Seti project is one of the best projects of the genre, because it not only generates 3,636 GWh of peak-in energy (750 MW of power) – good quality power – but such power at low cost and also results in flood control in downstream areas, mainly India and dry season augmented flow of 90 m3/s. Moreover, export of hydropower to India from this project results in carbon offset benefit which is tradable and is a good source of revenue.

Part I: Benefits, costs and allocation thereof

Downstream Benefits and Power Benefit

Although, there is no information available on the quantum of flood control benefit, but 90 m3/s of augmented flow during the dry season is worth $ 83 million (equivalent to Rs 5.81 billion) annually based on the principle set forth by the agreement between Lesotho and South Africa; for supplying 18 m3/s of water (both for the purpose of irrigation and drinking water) to South Africa, who pays Lesotho a lump sum of $25 million (in 1991 prices) each year from Lesotho Highlands Water Project. For purposes of both irrigation and drinking water we could also develop a mechanism to share such benefit on the precedent set by the Columbia Treaty.

Under Article V: “Entitlement to Downstream Power Benefits” of this treaty “Canada is entitled to one half the downstream power benefits”. The downstream power benefit has been defined by Article VII as “the difference in the hydroelectric power capable of being generated in the United States of America with and without the use of Canadian storage.” Drawing a parallel with the West Seti project, as the installed capacity of this project without a reservoir is just 100 MW, the power benefit of the construction of the reservoir is 650 MW and Nepal, under the principle established by this Treaty, is entitled to 325 MW.

Similarly, under Article VI of this treaty Canada gets a lump sum of $ 64,400,000 as “Payment for Flood Control” from USA. Additionally “the United States of America shall pay Canada in United States funds in respect only of each of the first four flood periods for which a call is made 1,875,000 dollars and shall deliver to Canada in respect of each and every call made, electric power equal to the hydroelectric power lost by Canada as a result of operating the storage to meet the flood control need for which the call was made,” moreover, under Clause (b) of Section 4 of this article US is required to pay to Canada a “compensation for the economic loss to Canada arising directly from Canada foregoing alternative uses of the storage used to provide the flood control.”

Unfortunately, the extant paper work between Nepal and the proponents of West Seti project has deprived Nepal of these innate rights. Nepal deserves to be recompensed for the downstream augmented benefit based on the lines of agreement between Lesotho and South Africa or on the basis of the precedent set by the Columbia Treaty. Failing to emulate the principles set in one of these treaties, there is no point in implementing this project.

Climate Change – Carbon Offset

Emission of carbon dioxide from the use of fossil fuel has resulted in global warming in a larger scale which in turn has induced climate change. In order to mitigate this problem, the Clean Development Mechanism (CDM) has been put in place which is a mechanism within the Kyoto Protocol that allows industrialized Annex I countries to implement projects that reduce emissions in non-Annex I countries (developing countries) and get credits for meeting their commitments to reduce emissions.

Generation of hydropower does result in environmental additionality due to carbon offset by it, in not emitting green house gases (GHG) in environment. As envisaged by Kyoto Protocol, trading in such carbon offset, also known as carbon credit, is already taking place. However, as Nepal is bereft of any fossil fuel exploration activity, and its use of such polluting source of energy as a source of energy is negligible and, therefore, Nepal’s baseline is deemed to be the hydropower which doesn’t pollute. Because, under Kyoto Protocol, a country like Nepal with hydropower as its baseline, environmental additionality is not deemed to be accrued by generating additional hydropower for domestic use, except in the case of hydropower plant of up to 15 MW. Therefore, most of the projects are not considered to be generating environmental additionality. Whereas, as West Seti project exports “clean” power to a country whose baseline is not hydropower, the transaction does succeed in offsetting carbon dioxide.

In view of this, export of hydropower from Nepal to India is a good candidate for trading in such carbon credits for which West Seti project is in a comparatively better position to do so. Of the annual generation of 3,636 GWh, this project is obliged to provide 10% to Nepal free of cost and it will be exporting 3,272 GWh to India each year. As one liter of diesel generates, generally, 4 kWh of electricity, export of power from West Seti will displace 818,100,000 liters of diesel each year in India for generation of power. As the emission factor for carbon dioxide (CO2) for diesel is 2.68 kg per liter[1], consumption of 3272 GWh of electricity imported from Nepal will offset 2,192,508 tons of CO2 in a year in India. Similarly, as diesel also emits Nitrous Oxide (N2O) and Methane (CH4) besides CO2 and the emission factor as given in the IPCC[2] for N2O is 0.032 kg CO2 equivalent per liter of diesel with global warming potential (GWP) of 300 and 0.004 kg CO2 equivalent per liter of diesel for CH4 emissions with GWP of 21. Therefore, the export of 3,272 GWh to India each year will also offset N2O by 26,179 tons of CO2 equivalent and CH4 by 3,272 tons of CO2 equivalent. In total the export of electricity from this project will offset by 2,221,960 tons of CO2 equivalent in a year. Such carbon offset has a market under Kyoto Protocol. Although the price of carbon offset ranges between $ 5-15 per ton of CO2 equivalent, for the sake of simplicity, using a median price of $ 10 per ton of CO2 equivalent yields a revenue stream of $ 22.2 million (equivalent to Rs 1.55 billion) per annum.

In view of the numerous benefits, as described above, that construction of this project will educe this is definitely one of the best projects of the genre. However, benefits don’t come alone and there are always numerous and matching costs.

The Costs

But there are costs (beyond the initial investment) involved in building this project in terms of environmental degradation, submergence of forest, cultivable land, etc. that Nepal will have to bear. The project’s reservoir inundates/submerges 25.1 km of the Seti River and a total of 28.0 km of five main tributaries (Chama Gad, Dhung Gad, Saili Gad, Nawaghar Gad, and Kalanga Gad) which displaces 18,289 people[3]. According to the same report “The permanent project features will require the acquisition” of 659 ha cultivated land, 806 ha forest, 169 ha shrubs, 246 ha grassland, 9 ha abandoned land, 5 ha settlement, 409 ha river feat. and 23 ha rock/cliffs/screes totaling 2,326 ha of land[4]. Similarly, 678 ha will be “utilized for the transmission line ROW.” In total the project will use 3004 ha land permanently. The acquisition of land as such is covered by the EIA report. The project proponent has plans on the anvil to rehabilitate the displaced people by providing land in lieu of cultivated land. However, the land occupied/cultivated by the displaced populace is just 659 ha of cultivated land, comprising 22% of total land to be acquired. In order to rehabilitate the displaced people, the project will be providing land in lieu for the cultivated land in Nepal. In this manner the project will be using Nepal’s additional land for the purposes of rehabilitation. However, the project has no plans to provide land in lieu of remaining 2345 ha land (3004 ha minus 659 ha) that the project is to use. An important question that arises is why Nepal should sacrifice 2345 ha land to provide good quality low cost power to India, which will also enjoy the benefit of flood control in rainy season and augmented flow in the dry season.

But, according to Dr Anand Bahadur Thapa, additional 1,630 ha land gets submerged permanently and 645 ha partially in Banke district, in Holiya, Bethani, Gangapur, Matehiya and Phattepur VDCs, resulting in displacement of 15,174 people, due to Laxmanpur “barrage” in India coupled with the augmented flow. This is not covered by the EIA report and, therefore, no rehabilitation plan has been put in place. This raises the question as to why an institution like ADB is associating itself with such a project. One is forced to wonder if it is happening with its concurrence or complicity.

Clause 7.2(d) of the Project Agreement and Rule 20 of Electricity Regulations, 2050 puts restriction on consumptive use of water in the upstream area in order to ensure adequate water for the project to generate electricity. This restriction adversely impacts following VDCs which will not be allowed to use water in the upstream area for consumptive uses like irrigation etc: Rayal, Dangaji, Parakatne, Bhairabnath, Chaughari, Kotbhairab, Malumela, Matela, Subeda, Luyata, Hemantabada, Chainpur, Sunkuda, Banjh, Khiratadi, Dahabagar, Pipalkot and Kapalseri in Bajhang District, Belapur in Dadeldhura District, Shivalinga, Dhungad, Sigas and Thalakada in Baitadi District and Lamikhal, Mahadevsthan, Dahalkakikasthan, Girichauka & Chhapali in Doti District. The project people are trying to undermine the importance of the issue by saying that there will not be any restriction on drawing of water by the people in these villages for the purposes of drinking. The important issue here is the water for irrigation purposes. Due to the restriction imposed by Clause 7.2(d) of the Project Agreement and Rule 20 of Electricity Regulations, 2050 no new irrigation work will be allowed to be undertaken in these villages. Their attempt to obfuscate the mater will not help the project. Rather, this is the best way to lose their own credibility in the eyes of the people adversely impacted by the project in particular and others in general. Water also will become unavailable for use by locals in the de-watered area which adversely impacts Bayarpada, Banlek, Jijaudamandu, Latamandu and Pachanali VDCs in Doti District and Belapur in Dadeldhura District. The environmental flow of 10% that the project is required to leave in the dewatered area will not be adequate for the residents of the villages on the banks of the dewatered river to undertake irrigation work.

Allocation of Benefit and Cost

After having established the various benefits and costs of the project it is time to assess how such benefits and costs are allocated, which is depicted in the table below:

From the above table it is clear that all of the costs have to be borne by Nepal while benefits go to India making one wonder why Nepal is allowing implementation of such a project. The question that occurs to patriotic/nationalist Nepali people is why should Nepal sacrifice 4,634 ha of land permanently and 645 ha partially in order to provide (a) good quality power at low cost, (b) flood control and augmented dry season flow free of cost to India and (c) also carbon offset benefit to India. As a country there is sense in inundating its land mass in one area in order to benefit other area in terms of flood control and augmented flow which will make multiple cropping possible, including off season planting of high value agricultural produces. But that is not the case here.

As the issue of good quality power at low cost to India is dealt with below, the issue of flood control and augmented flow will be briefly discussed here. It does not require the knowledge of rocket science to understand that building a reservoir – to store the rainy season water and use it during the dry season – does indeed result in flood control during the wet (rainy) season and augmented flow during the dry season. In view of the fact that Seti is a relatively small river compared to Karnali (Ghagra in India) River, although the flood control benefit by building the reservoir will definitely accrue, but may not be highly significant.

However, there is no doubt whatsoever that the retaining water of the rainy season in the reservoir built for electricity generation will augment the flow in the Seti River in the dry season and, consequently, in Karnali in Nepal and Ghagra in India substantially. As 75% of the dry season flow of Ganga River is contributed by rivers in Nepal, Karnali being one of the major ones, the incremental flow will be significant. Only issue that needs to be settled is the quantum of such augment flow, objectively. Dr Anand B Thapa, an eminent scholar, has opined that it will amount to 90 m3/s while others feel that this is slightly overestimated quantum. The issue that needs to be debated is not how much will be augmented – which can be scientifically assessed – but why should Nepal have its land, forest, infrastructure, etc. submerged and have its populace displaced in order to provide additional fresh water to India free of cost. There are people in Nepal who are happy to surrender everything to India, even Nepal’s sovereignty, while paying lip service to the spirit of working to the best interest of Nepal and its people. But the majority, thankfully, will never agree to the sell out of Nepal’s interest in any form. Unfortunately, the majority is neither well informed nor is in a position to stop the hydrocracy (politicos, bureaucracy and intellectuals involved in water resource sector development) from signing away Nepal’s interest, in treaty after treaty; manifesting in the treaties for Nepal’s major rivers like Koshi, Gandaki and Mahakali[5]. That was a phase where such bi-national treaties were signed and a lot of controversy raised. These people, with the inclusion of Article 126 in the Constitution of 1990 (Article 156 in Interim Consitution), requiring ratification of such treaties by simple majority in the case of treaties of ordinary nature and by two-thirds in the case of treaties that affect the nation extensively, seriously or in the long term, have changed track. They are now putting forth fronting companies which secure Indian interest in Nepal’s water by getting licenses for hydropower. Thus in the name of hydropower development, Nepal’s land, forest, infrastructure, etc. is submerged and have its populace displaced to provide flood control benefit and augmented flow in the dry season free of cost to India.

India's union water resources minister Mr. Saif Uddin Soz had been frank and honest in admitting, with Navin Singh Khadka, BBC Nepali Service, 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.”[6] This is the first time that an Indian official (of highest level) has been candid in admitting as much. Surprisingly, however, this has yet to be understood by Nepal’s hydrocracy. Or it may be a case of them pretending not to understand it, in order ensure that Indian interest is served by implementing projects in the name of hydropower that afford flood control benefit and augmented flow at no cost to India. What galls ordinary Nepali citizenry is the fact that these people parrot the statement that they are working to serve the best interest of Nepal and its people while betraying the nation and the population no end.

This breed of “patriotic” people even sarcastically dismiss the issue by saying that the water from the tailrace of the West Seti project will not just jump into Indian territory and go on to add that between the tailrace and Indian territory the augmented flow traverses over 100 km of Nepali territory. What they don’t admit is the fact that if West Seti project isn’t built as a multipurpose project, with an objective to irrigate Nepali land by using the augmented flow, the augmented flow will fall in Indian lap as a low hanging, ripe fruit, and after using such water during a couple of seasons, they will have a strong case to invoke the principle of “existing prior consumptive use.” It is well known by now that using this very principle the water from Mahakali River – deemed to be a border river and each country being entitled to half water – India got away with 96.5% water and leaving just 3.5% for Nepal. Interestingly, this breed of people even come to the defense of the treaty – and by extension India – by arguing that it doesn’t make sense for Nepali people to clamor for 50% share of the water when Nepal isn’t even able to use 3.5% (such is their patriotism!).

They further demonstrate their “patriotism” by adding that even the water in the rivers flowing in Nepali territory – forget the border rivers – does not exclusively belong to Nepal. They profess to subscribe to the principle of “international water course” and assert that India too has right to the water in such rivers in Nepal. If that is the case then Nepal too has right to the water in Nepali rivers while they are flowing in China. But they never dare to raise voice as such, except to assert Indian right over the water in the rivers in Nepal. This is a shockingly subservient view, as Indian government has already acceded that “HMG shall have every right to withdraw for irrigation and for any other purpose in Nepal water from the Kosi river and from the Sun-Kosi river or within the Kosi basin from any other tributaries of the Kosi river as may be required from time to time. The Union shall have the right to regulate all the balance of supplies in the Kosi river at the barrage site thus available from time to time and to generate power in the Eastern Canal” pursuant to Clause 4 (i) of Koshi Agreement[7]. It is clear that these people are – advertently or inadvertently – furthering Indian interest, but the Indian government does not seem to subscribe to the principle these very people swear by. Otherwise India wouldn’t have built the Farakka barrage to divert water from Ganga River to Kolkata, thus depriving Bangladesh of the water she is rightfully entitled to – thereby leaving the Dhaka port high and (literally!) dry.

Even if one was to accept the logic of international water course, the augmented flow will not be the “same” water. What the proponents of this concept need to understand is that the augmented flow generated by storing it in a reservoir inundating Nepal’s land is the water with temporal value added by Nepal. Therefore, Nepal is entitled to the “value” that has been created/added by way of storage of such water in Nepali territory. The problem lies in their mindset that the water flows down to India anyways. The water that flows down during the normal course is the water which is devoid of any value addition. Such water even causes flood during rainy season. But by building a reservoir additional value has been created/added on the free flowing water. Therefore, Nepal is entitled to a “fee” for the value added as such. People advocating allowing such value added water to India free cost can in no way be deemed to be working for the interest of Nepal and its people. This thinking on their part is the other half of the oxymoron statement that the water normally flowing in the river is waste of “valuable” water. They don’t tire of attributing value (hence the relevance of wastage) to the normally flowing water which is bereft of any value addition (neither spatial, nor temporal) but are adamant to bestow value added water free of cost to India.

Carbon offset does indeed occur by the export of hydropower from Nepal to India. It is also true that, due to submerged vegetation in the reservoir, methane is indeed generated by the reservoir. If the carbon offset by the former is more than carbon equivalent emitted by the latter, then there is considerable value in such carbon offset. A pragmatic approach on the part of Nepali hydrocracy would have been to ensure that Nepal isn’t shortchanged of the proceeds of carbon trading emanating from the export of hydropower from West Seti project. But this section of hydrocracy that profess their love for Nepal, wish that no question like this is raised such that Indian establishment becomes annoyed at the ineffectiveness of Nepali hydrocracy in protecting the Indian interest. West Seti project management opines that carbon offset hasn’t been traded for projects larger than 200 MW. There are two issues: One, there is no harm in trying for a larger project. Two, it is incumbent on the part of GoN to ensure that if any carbon offset from this project is traded in the future, Nepal’s rights are protected.

Therefore, under the arrangement for West Seti project, Nepal gets shortchanged in many ways. She has to internalize various costs like inundation/submergence by the reservoir and in Banke district, displacement of people by the reservoir and in Banke district, restriction on consumptive (irrigation) use of water in upstream area, unavailability of water in de-watered area to irrigate. While providing good quality power to India at low cost on top of providing benefit from flood control, augmented flow and carbon trading.

In this backdrop one wonders why Nepal is determined to go ahead with this project! The transfer of the power plant to Nepal after 30 years, free of cost has been used (even by the Supreme Court) to justify Nepal internalizing all the costs mentioned above to export peak-in energy at rock bottom price. However, India will keep flood control and augmented flow benefits permanently (even after handover of the plant in 30 years) as “existing prior consumptive use” principle will kick in while Nepal will lose 3004 ha under the reservoir and 1,630 ha permanently, 645 ha partially in Banke due to Laxmanpur “barrage” coupled with the augmented flow to India. In this backdrop it is hard to accept that even Supreme Court verdict has served national interest.

What has been said by the project proponents (echoed with glee by Nepal’s hydrocracy) is that Nepal will receive a project worth $ 1.2 billion free of cost in 30 years. This has got a cross section of Nepali hydrocracy enthralled which has succeeded in spreading the contagion to the uninformed general public. It needs to be remembered that the Present value of $ 1.2 billion to be received in 30-year hence is just $ 68.77 million – not a huge amount worth to be excited about. Similarly, looking at it from another perspective, depreciated value of the asset worth $ 1.2 billion today in 30 years is just, again, $ 48 million (after depreciating the property for 24 years). As the old saying goes, it will be tantamount to people going about bragging about having put on some weight while it was merely a case of swelling of the body. Because, thirdly, by then, although the civil works part may be in a fairly good condition but same will not be true in the case of electro-mechanical equipment which needs to be replaced in 25-30 years.

On the contrary Nepal stands to be shortchanged of $ 2.075 billion (at current price level) for the augmented flow of water over 25 years[8], even if Nepal is to get back the augmented flow too after the handover of the project. Similarly, Nepal also is not going to receive $ 555 million for the carbon offset during 25 years operation of the plant that she is entitled to. Moreover, it also needs to be remembered that this calculation does not take into account the power benefit that is due to Nepal.

In this scenario, Nepal does not get what is rightfully due to it. But even after hand over of the project India will continue to keep benefit from flood control as well as from the augmented flow. She will end up having right to these permanently as she will use the principle of “existing prior consumptive use.” In Nepal’s case, the land inundated by the reservoir and Laxmanpur barrage will continue to remain unavailable to her permanently, till decommissioning of the plant.

Besides, there is the issue of decommissioning[9] which both the hydrocracy and the project people don’t like to talk. Although the main source of Kulekhani reservoir, for example, is not based on silt laden river, the dead storage of this reservoir is already 25%. In other words, the capacity of Kulekhani reservoir has diminished to 75% of original capacity in about 2 decades. Same (the role of silt) can also be seen from the rise of river-bed of Koshi River by 4 meter, by now, compared to the level of the land in the surrounding area. Seti too 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 cost more than the initial investment to build this project.

Part II: Economic Assessment

An objective assessment of a project also needs its economic assessment. The best way to do so is by examining/analyzing various linkages to the economy like backward, forward, investment and fiscal linkages of the specific projects. As the reader has already perused this issue in my paper titled “Irrelevant debate of small vs. big” (posted below), only the mark sheet is recapitulated below:

One can easily make an assessment of this project by compiling the marks it secured as follows:

The aggregate mark secured by this project is the lowly 16.55 out of a total of 308.5 which comes to just 5.36%. 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 308.5 then that project enriches the economy a lot than a project like West Seti.

Part III: Recommendations and Conclusion

In view of the above, the only condition Nepal should allow implementation of this project is by adopting the principles established by the Columbia Treaty. Nepal should receive 325 MW as power benefit under Clause V and payment for flood control under Clause VI which recognizes that the upstream country is entitled to “compensation for the economic loss to Canada arising directly from Canada foregoing alternative uses of the storage used to provide the flood control.”

Alternately, India should provide land in exchange of inundated/submerged land of over 4,000 ha pursuant to precedent set by Sarada Agreement of 1920, the 3rd clause of which reads: “That the Nepal Government would transfer necessary land for the construction and maintenance of canal works which is provisionally estimated at 4,000 acres and would receive land equal in area from the British Government.” because, the inundated/submerged land under the reservoir will never become available for economic/productive uses by Nepal.

If above structure is unacceptable to the stakeholders, then the project should be structured as described in following lines. It should be built as a multipurpose project in order to irrigate land in Nepal and the dam height should be fixed according to irrigation need of cultivable land in Nepal. Therefore, the inundation/submergence of land in Nepal should be commensurate to the extent of Nepal’s irrigation requirement only. The electricity should be used to meet Nepal’s need of peak-in energy demand and export only excess energy to India, not power. Besides, as long term PPAs yield low tariff (and vice versa – depicted by the diagram below), no long term PPA should be executed. Only short term PPA should be signed with an eye on Nepal’s need each five-year blocks.
The proponents of the project seem to be trying to obfuscate the important (with high value for Nepal) issues by citing indirect benefits to Nepal in terms of employment generation etc. occurring during construction period which automatically occur in the alternative models recommended above. Similarly, they have a litany of “anticipated spin off benefits” which too does take place in the recommended models above.

[3] Source: Environmental Assessment Report, prepared by West Seti Hydro Limited for ADB. [4] As specified in “Table 3: Land Use on Sites to be Permanently Acquired” of Environmental Assessment Report prepared by West Seti Hydro Limited for ADB.
[5] First signed away in the name of MoU for Tanakpur power project, but after the intervention of Supreme Court, in the name of package deal, Nepal was betrayed by signing a treaty for the whole Mahakali River which was even ratified by the Parliament – an act of national betrayal. [6] A transcript of the interview has been published in Nepali Times weekly, 19-25 Sept 2008, #418.
[7] Source: “Revised Agreement between His Majesty's Government of Nepal and The Government of India on The Kosi Project.”
[8] Based on the precedent set by the agreement between Lesotho and South Africa.
[9] Decommissioning means either stopping production of electricity from the plant or the demolition of the civil and electric infrastructure in order to restore the river ecosystem, minimize or eliminate safety hazards and put the river and land resources back to economically productive uses, when the useful life of the project expires.

This is the paper presented in the workshop organized by Jalshrot Vikash Sanstha on September 26, 2008 on "West Seti Project" where the only other paper was presented by SMEC, the proponents of West Seti project.

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

Sunday, November 9, 2008

Investment in Hydropower Sector in Nepal: Opportunities and Risks

It is remarkable that, during past one decade, domestic investors have invested US$75.5 million and foreign investors $233.6 million in the electricity generation business in Nepal. Similarly, $13.5 million was invested in buying shares in Butwal Power Company held by the Government of Nepal. Thus, in a span of one decade, the private sector has succeeded in mobilizing $322.6 million into the power sector. The details of the investment are as follows:

According to National Planning Commission, at the end of 9th Five Year Plan, 40% of the population in Nepal had access to electricity while the percentage has increased to 48% in fiscal year 2005/6.3 It means that 52% of the population still has no access to electricity. This indicating that there is a solid market for electricity in Nepal. Further, it also needs no reminding that most of those who have access to electricity are facing severe load-shedding and the magnitude of which is likely to increase further in the near future.

Moreover, as total domestic consumption of electricity in fiscal year 2006/7 is 2,179.89 GWh[4], the per capita electricity consumption in Nepal works out to 87.19 kWh (based on the estimated population of 25 million). The per capita consumption in prosperous occidental countries is above 20,000 kWh whereas Nepal will need to have the installed capacity of 60,000 MW at 50% plant capacity factor even to attain 10,000 kWh per capita level. On more practical level, from the macro perspective, electricity comprised the source of energy for only 2.5% of the population[i] (following chart will be able to elucidate the point better). Just to increase this proportion to 50% of the population, Nepal will need to have the installed capacity of over 12,000 MW in its system for domestic consumption.

Energy consumption in 2006/7: 8.478 million toe (estimated)

All this confirms that an abundant market for electricity exists within Nepal. If one is to include the potential export market of electricity to India then the size of the market increases by a magnitude.

The tremendous market for electricity manifests investment opportunity. In other words, the scope for investment in hydropower in Nepal is limitless. In this respect, it needs to be remembered that ramification of investment in hydropower sector is equity investment by the entrepreneurs with complementary debt financing from financial intermediaries (FIs). It is not possible for an entrepreneur to implement a hydropower project just by making an equity investment. From this perspective, implementation of a hydropower project also depends on an entrepreneur’s ability to mobilize debt funding. However, there are some major constraints in mobilizing funding from FIs for investment in a hydropower project, which are detailed below.

Market failure and portfolio mismatch in FIs
At present, Nepal is facing a market failure condition in its economy, high liquidity in the system leading to very low interest rates on deposits offered by FIs, while very few of them have experience with, or appetite for, long-term infrastructure projects, which are invariably capital-intensive. Projects needing long-term financing have been facing problems in securing finances. There are seven national level development banks mandated for long-term financing while a number of commercial banks are also financing long-term projects to an extent. However, the terms of the debt offered by these banks and their capital base are limited.

The market failure condition described above is due to the fact that their deposit base is of a short-term nature and it will be a portfolio mismatch for them to offer long-term loans. This condition is inhibiting FIs from assisting private developers in participating in the power sector development in the requisite way.

Lack of ‘project finance’ instrument
Project finance is specific mode of financing used by FIs under which the very project for which finance is being sought is accepted by FIs as collateral and no additional or external collateral is required for the purpose, thereby resulting in limited recourse to the institutions providing debt financing. This is also called non-recourse financing. In this kind of financing, the proponent does not need to lodge other tangible or intangible assets as collateral. However, FIs in Nepal do not ‘like’ project finance, and, therefore, a proponent is required to put a tangible or intangible assets of value higher than the debt amount to include a margin as collateral, or to furnish corporate or personal guarantee or third party guarantee or parent company guarantee, and so forth.

Throughout the world, investors have not been financing front loaded projects, like hydropower, fully with their equity (even if they were capable), nor would it be prudent for them to be exposed to the assortments of risks just on their own. Project finance is a mechanism for sharing the exposure to such risks in the proportion of debt equity ratio. In order to encourage developers to participate in the power sector, FIs need to make available funding on ‘project finance’ basis.

Lack of ‘due diligence’ capability in FIs
Financing hydropower can not be compared to any other financing. In order for an FI to lend for hydropower projects, it will have to be able to understand the project intimately. Uniquely, the hydropower sector uses a number of disciplines, like civil, electric, and mechanical engineering, hydrology, geology, etc. Without contribution from each of these disciplines, it will not be possible to form an opinion about a project and to determine whether it is bankable or not. However, no FI in Nepal possesses this kind of expertise in house. Because of this constraint, banks have shown hesitation to invest in the power sector.

Another facet of the same problem is that FIs do not like the project finance instrument simply because they do not have the necessary ‘due diligence’ capability.

Central bank guidelines insensitive to power sector
Nepal Rastra Bank (NRB), the nation’s central bank, has certain rules regarding provisioning in its guidelines to banks in Nepal. The NRB requires banks to make a 1% provision for ‘good’ loans; i.e., loans that are overdue by less than three month. Loans overdue by three to six months are called ‘substandard’ loans, and the provisioning requirement for such loans is 25%. Loans overdue by six month to a year are termed ‘doubtful’, and 50% is required to be provisioned for such loans. The provisioning requirement for loans overdue by more than one year is 100%.

In the power sector, the time overrun by one year is held to be normal (the Middle Marsyangdi Project was scheduled to be commissioned in 2004, but it is still under construction!). If banks started making 100% provision for their investments in the hydropower sector, they would become insolvent and would also adversely impact the power sector as well as the economy of the country.

Power development fund
In order to finance local Independent Power Producer (IPPs), the Government of Nepal established the Power Development Fund (PDF) with the support of the World Bank. With a start-up capital of US$35 million, the PDF intends to finance 60% of the cost of projects up to 10 MW and 40% of the cost of projects above 10 MW. The fund is administered by the Nepal Bangladesh Bank Limited, a private commercial bank in Nepal.

The PDF has yet to finance any project because the criteria for qualifying for PDF financing are too rigid for compliance by small IPPs. The criteria require prior clearance from the environment department to qualify for a loan. This usually takes more than two years. Developers cannot wait for such a long period. The resettlement issues are too stringent and are more relevant to large projects than to small projects. The proposal screening criteria are as per the international development agency guidelines, which is very time-consuming. The three stage due diligence process of the PDF itself takes over 180 days. The purpose of establishing the PDF to help finance local IPPs has thus not been met due to the preconditions set down by the PDF. Recently, adding to the complications, the administrator (i.e., the bank appointed to administer the PDF) has been taken over by the NRB after declaring it troubled.

Financing a hydropower project is very heavily dependent on the prudent management of various types of risks. This involves identification of various risks associated with a project and assessment thereof. However, the most important step lies in arranging measures to mitigate such risks including an effective insurance program. Let us take a look at certain important risks from the perspective mentioned here.

Foreign exchange risk
A developer can borrow locally or from foreign institutions and the conditions with regard to security will be same. However, the borrower’s exposure to certain risk will be different if the source of debt is overseas. There are mainly two types of risks that a borrower needs to be aware of while borrowing from a foreign lender.

A foreign exchange risk is inherent in foreign loans due to the fact that foreign currency tends to be relatively strong compared to Nepalese currency. This risk materializes with the devaluation if revenue is denominated in local currency while having to service the loan denominated in foreign currency. Similarly, this risk also does manifest in rising cost of imports. This risk can be mitigated by either (a) having the loan denominated in local currency, or (b) rate of revenue denominated in foreign currency. In the case of increase in the cost of imports an insurance coverage against cost escalation would mitigate this risk.

Repatriation risk
Another risk associated with foreign loan is ‘repatriation risk’. This becomes of greater concern to a lender if it is not able to repatriate the proceeds of debt servicing. Generally, governments of development countries, in their quest to attract foreign investment, have enacted legislation guaranteeing repatriation. If such a guarantee is not available, either the lender will not make a loan or will make it subject to exorbitant rate of interest. In Nepal repatriation is guaranteed by the Foreign Investment and Technology Transfer Act of 1992 and the Electricity Act of 1992 for hydropower projects. A foreign equity investor is also subject to this risk.

Sovereign risk (country risk)
A foreign entrepreneur investing in Nepal is exposed to risk such as those associated with the government’s credit worthiness, the possibility of confiscation, expropriation and nationalization (CEN Risk), changes in the local political environment and enforceability of contracts. These types of risk are known as sovereign and country risk. The Multilateral Investment Guarantee Association (MIGA), a member of the World Bank group, ensures against such risk for a fee. However, the availability of such insurance is limited only to foreign investors.

Interest rate risk
It is now time we also touched upon the concept of interest rate risk. Lenders offer two kind of interest: (a) floating rate and (b) fixed rate. Floating rate entails changes in the interest rate during the term of the loan, thereby introducing an element of uncertainty or risk for the borrower. Banks prefer floating rate as they need to be able to adapt to changes in financial market as well as cover their own exposure to the vagaries of changing interest rates (including bank rates). For a developer, fixed rate is the best way to mitigate this risk. However, banks tend to add a margin to the then prevalent rate to cushion their own risk.

Inflation risk
The real value of a unit of nominal currency tends to depreciate over time with inflation. Even hard currency is subject to this risk. Escalation in the rate of tariff is the only answer, short of trying to hold down the inflation with one’s bare hands!

Legislative change risk
Here we are talking about the risk of changes in the country’s laws that (a) increase rates and taxes or other expenses and liabilities, (b) reduce project revenues, or (c) reduce the value of the assets. Such changes adversely impact the viability of a project. Generally, an entrepreneur has to take such risk. However, it can also be mitigated by passing the impact through to the utility provided that the utility is amenable to such a pass through.

Market risk
It is common knowledge amongst engineers that energy requires a guaranteed market due to the constraints with regard, primarily, to storage and transmission. A simple way to mitigate this risk is to sign a long term Power Purchase Agreement (PPA) with the utility.

Revenue risk
A developer can have a long term PPA, but such a PPA may not ensure plant factor at a specific level if the utility accepts delivery of the energy at its pleasure, mainly in the case of a run-of-the-river type project lacking poundage. This means there will not be a guaranteed stream of revenue to the project in order for it to meet its financial obligations with regard to (a) operation, maintenance and repairs, and (b) debt servicing. A ‘take or pay’ type of PPA mitigates this risk.
However, with respect to both market risks and revenue risk, it needs to be noted that electric energy is already being traded in spot markets in Western Europe.

Payment risk
This risk emanates from the lack of creditworthiness on the part of the utility, the buyer of the energy. In many developing countries, state owned utilities do not have established credit histories and also suffer from records of poor management, over-employment, high leakage
(technical or otherwise), etc. Developers are known to ask the government to issue a counter guarantee to cover the payment risk. This basically entails a government standing surety to the fact that the utility pays its dues to the developer in time, and in the case of a utility’s failure
to meet its obligations the government is required to promptly make payment to mitigate the delinquency of the utility. Now-a-days multilateral funding agencies like The World Bank take a dim view of a government issuing a counter guarantee. Having a letter of credit put in place by the utility with the IPP as the beneficiary is another way of mitigating this risk over the short term.

Construction risks
Time and cost overrun risks are one group of construction risks. Time overrun risk results in loss of revenue and may also raise the cost due to inflation. It also raises the total amount of interest during construction of the debt financing and may even attract penalties for late delivery of energy. Other construction risks are force majeure risk, socioeconomic/environmental risk, geological risk, performance risk, design risk, etc. One can arrange insurance coverage against such risk like CAR, TAR, EAR, professional liability, etc., including ‘advance loss of profit insurance’ that can be complemented by signing a ‘fixed price’ turnkey contract (or EPC contract) and incorporating a clause for imposition of liquidated damages on the contractor for delayed substantial completion or commissioning of the plant.

Hydrological risk
The ‘take or pay’ nature of the PPA guarantees that all energy produced by a plant, depending on the availability of water, irrespective of whether the season is dry or wet, shall be turned into cash.

However, if there is no water to generate energy due to the change in the level of precipitation, climatic reason or change in the hydrology of the catchments area, then these projects are on there own. This risk emanates from the fact that seasonal rainfall patterns affect the amount of water available to a hydropower plant and generation may fall below contract levels in any season, thus threatening the revenue stream of such projects. Obviously, a dry year will be an unmitigated disaster for a hydropower plant. The most effective way to mitigate hydrology risk is to gather hydrological data for reasonable number of years in the past and design the project accordingly, after having selected a project with better hydrological potential as well as information.

There is no need to be frightened by the list of risks dealt with above, as most of the risk can be mitigated in some way or other. There is an old saying: ‘no risks, no gain’. The entrepreneurship lies in taking risk and also being able to manage it. If an investor is able to do so then there is ample opportunity to invest in hydropower sector in Nepal. However, necessary measures must be undertaken to mitigate the constraints in financing power sector, described above.

End notes
1. As these are ballpark numbers converted into US Dollars from Nepalese currency, there may be minor differences.
2. One of the main foreign equity investors in the Bhotekoshi Project has already sold its shares to an investor in Nepal.
3. The breakdown of this 40% has been given as: 33% covered by Nepal Electricity Authority, 2% covered by alternative modes of electrification, and 5% electrified in unexplained way(s). But according to the data published by NEA, its coverage is less than 25%.
4. The generally accepted debt equity ratio is 70:30.

Published in The Nepal Chartered Accountant, Journal of the Institute of Chartered Accountants of Nepal- September/December 2007.

Sunday, November 2, 2008

"Unbundling may not solve load-shedding"

Interviewed by Nepali Times about the effects of the new electricity ordinance on the anvil that will break the NEA into three components, for Issue #285 (10-16 Feb 2006).

Nepali Times: What do you think about the electricity ordinance?
Ratna Sansar Shrestha: Actually, I'm not fundamentally opposed to unbundling. I believe competition in the electricity sector will definitely help consumers as well as other stakeholders and make the market itself competitive. I am more apprehensive about implementation. So, instead of one big sick organization that is losing Rs 2 billion per year we may just end up with three small sick organizations.

Why is the idea being mooted, especially by the means of ordinances, at this time?
That is a mystery to me. I don't see why the hurry at a time of instability which means there isn't a wider discussion on the pros and cons. Besides, splitting the NEA has long term implications, while an ordinance is an instrument valid for six months only.

Why wasn't it put forward when your team was in the NEA?
The new Hydropower Development Policy 2001, did envisage unbundling the NEA but parliament survived only six months after that. By the time I was nominated to the NEA board parliament had been dissolved. But I can confide in you that we did start work on unbundling the NEA which to an extent has paved the way for the present move.

In the early 1980s donors including the ADB helped set up the NEA now they want it dismantled.
Changing horses in midstream seems to be as much a donor habit. Yes, poorer economies like ours have been subjected to the covenants imposed by these multilaterals and many of their conditionalties are problematic. If one looks at this particular concept dispassionately it is clear NEA has too small a system (just about 465MW of its own and about 149MW belonging to IPPs, already unbundled) to warrant splitting. The action could very well end up costing more to consumers as the unbundling only increases the number of institutions ending up as an opportunity for powers-to-be to hire more CEOs and leading to unnecessarily high expenses. Besides, post-unbundled successors of NEA could still continue to be subjected to interference from bureaucrats and politicians.

So you think it may not be the right solution?
In Nepal many plans that look sound on the drawing board have floundered when put to practice. There is a danger the economic model will be called total failure and people will again clamor for reintegration of the NEA. This will be very messy. The ordinance has a single-minded focus on splitting the NEA while it is silent on how competition at both wholesale and retail levels will be instituted.

Do we have the right and adequate infrastructure for the unbundling of, say, distribution and especially if the private sector is allowed in?
Forget the infrastructure which will have to be thought through and created, even its layout is not visible in the draft ordinance. With due respect to my colleagues in the private sector, they will exploit any loophole available and the whole exercise could boomerang on the economy and consumers. Stronger and stringent regulatory mechanism needs to be placed before allowing the private sector to play a significant role in the electricity market to ensure forward linkages vital for the economy.

Given the fiasco of the tariff fixation commission how optimistic can we be?
Even when I was a board member of NEA we requested the commission for introduction of seasonal tariff in view of the fact that NEA was spilling more than 700 GWh of electricity at that time (we are still spilling 500 GWh). But one or other excuse was trotted out and nothing happened.

How would the new plan rope in the private sector?
First of all, the private sector does not just include business houses. Community-based cooperatives, users' groups, NGOs are also private initiatives, with or without profit motive. If you drop by the office of Community Rural Electrification Department (CRED) of NEA you will be amazed by the groundswell of support for NEA's efforts to involve communities in rural electrification. So many communities are coming forward under the 80:20 program that CRED is overextended. The immediate problem in the power sector is load shedding and Ministry of Water Resources officials themselves admit that the unbundling is not the answer to load shedding.

Will the new ordinance enable us to be in a better position to deal with, say, India in power related issues?
On the contrary, it may weaken the position as the splinter NEAs negotiate with, lets say, India's Power Trading Corporation. They will be a much weakened institutions. But export of energy is a different Pandora's Box entangled with security perceptions of our southern friends.