Saturday, July 10, 2010

Policy, Legal and Regulatory Framework for Hydropower Development

Ratna Sansar Shrestha, fca

Infrastructure projects including hydropower used to be a matter in public sector domain. Besides, these were also deemed to be the natural monopoly and were thought logical for a public enterprise to handle. However, in order to introduce the element of competition in the hydropower sector, an attempt was made to attract private sector investment. The mechanism adopted for the purpose was granting of concession, to be regulated by the license. It could be in the format of build, own, operate and transfer (BOOT) or build, own and operate (BOO). Toll roads, bridges, etc. have been handled in this manner in a number of countries. Even in Nepal suspension bridges in the rural areas have been built and operated in this fashion.
History of Hydropower policy in Nepal
The then Government of Nepal formulated Hydropower Development Policy in 1992. It was introduced as an interim measure to cater to the country’s energy requirement of 7-12 year, the period needed for completion of two specific projects: Arun III (402 MW) and Kali Gandaki (100 MW). “Electricity Act, 1992” and “Water Resources Act 1992” were promulgated as the instruments to implement policy.

However, the enactment exceeded the policy in as much as it has provisions for reservoir projects, export oriented project, etc. One of the anomalous example is West Seti (750 MW) which is an export oriented project. Similarly, license issued was also issued to the famed Enron for Karnali project (10,800 MW). Happily, however, this license died with Enron’s demise.

Policy guided by fallacies
This policy referred to here is guided by fallacies related to water, market for power and fund for investment. The main water related fallacy is that the water flowing in the river is a waste of resource. Additionally, water is equated with energy only, that too for export; ignoring multidimensional uses of water. The policy has failed to recognize that there is no alternative to water for the purposes of drinking, sanitation, irrigation, fishery, industrial use, navigation, etc. Besides, water is also required for religious ceremonies and water sports based tourism. There are many sources of energy besides water like. Solar rays, wind, geothermal, biomass, biogas (human/animal waste), etc. which are renewable and clean. Coal, petroleum products, nuclear, etc. are non-renewable and unclean sources of energy. Renowned politico-economists have predicted wars over water.

Another fallacy regarding hydropower is related to the notion that there is no market for electricity in Nepal; for her famed economic potential of 43,000 MW. Very few people know that Iceland consumed world’s highest quantum of electricity at 31,147 kWh per capita in 2006 whereas Nepal’s consumption was just 70.865 kWh per capita[1]. At the present rate of population growth, Nepal’s population will reach 40 million in 2030 and if 43,000 MW economic potential is fully tapped and electricity is generated at 50% plant factor, the per capita electricity available for consumption will reach 4,709 kWh only. Conversely, the installed capacity necessary to reach 15,000 kWh per capita (less than half of what is consumed in Iceland) is 137,000 MW which is more than 3 times of Nepal’s economic potential.

The fund related fallacy is partly true as there is “no money in Nepal.”  However, that is not the full truth. There was over Rs 674 billion in deposit in banks and financial institutions as of Jul 2009 (excluding other financial intermediaries that aren’t regulated by Nepal Rashtra Bank. The economy is lacking investment opportunities and the investment is going to unproductive sectors. Just ten percent of such deposit is sufficient to implement 449 MW at the ballpark cost of US $ 2 million per megawatt. Similarly, most of the proceeds of remittances are being put to unproductive uses. It is said that remittances of about Rs 200 billion a year is received through banking channel which is adequate for 1,333 MW.

Evolution of Hydropower Policy
The Electricity Act, 1992, promulgated to implement Hydropower Development Policy, 1992 was amended by Income Tax Act 2001. New Hydropower Development Policy, 2001 was promulgated but it is yet to be made enforceable because Electricity Act 1992, promulgated to implement older policy is still in force. Draft new “Electricity Act” is on the “anvil” since 2001.

Salient features of the policy
The following are the main salient features of current hydropower development policy.

1.         Concession Mechanism
Those wishing to invest in hydropower projects are allowed to do so under concession mechanism, under which the developer is granted a license to develop/implement the project and own and operate the project for a specific span of time. Upon completion of the license period, the developer is required to transfer the project to government of Nepal free of cost.

2.         Water Rights
The license granted to the developer guarantees right over specified quantum of water (flow) in a specified area (within specific coordinates) affording specific “head” for a specific period. The specifics of such water rights are regulated by the license which enshrines a guarantee against diversion of water in upstream areas.

3.                  Project license
There is provision for the issue of license for the construction of the hydropower project and generation of electricity. The license could also be to erect transmission network or distribution network and operate the respective network. Currently the licenses are granted on first come first serve basis which basically is non competitive in nature.

The licenses for any of the above activities are issued in two phases. In the first phase survey license is issued which enables the licensee to conduct feasibility study. If the project is found feasible upon completion of such study, the licensee is issued with implementation license to enable to implement and operate the activity covered by the license.

4.         Project Site
There is provision to make public land, forest and even private land available to the licensee for the implementation of the project.

5.                  No Confiscation, Expropriation and Nationalization (CEN).
Besides the constitution of Nepal, Electricity Act also guarantees that the hydropower project will not be subject to confiscation, expropriation and nationalization without compensation.

6.         Environmental Provision
There is provision for guaranteed minimum flow in the “dewatered area” and downstream areas which is also known as “environmental flow” which the project will be required to spare. Besides, the licensee is required to conduct environmental impact assessment (EIA) or initial environmental examination (IEE) based on the size of the project.

7.         Concession Fee (royalty)
The developer is required to pay capacity royalty at the rate of Rs 100 per kW during first fifteen years after commissioning of the project. Energy royalty at the rate of 2% is applicable during this period. Sixteenth years onwards the capacity royalty has to be paid at the rate of Rs 1,000 per kW and similarly energy royalty has to be paid at the rate of 10%.
8.                  Tax and Duty Facilities
As envisaged by the Hydropower Development Policy, 1992, Electricity Act 1992 has exempted income tax completely for hydropower projects of up to 1 MW and for first 15 years for the rest. From 16 years onwards hydropower projects are required to pay income tax at a rate lower by 10% of corporate tax. However, this facility was completely withdrawn by Income Tax Act, 2001. The exemption was reinstated with some modifications by Finance Act, 2009 under which power projects commissioning by April 13, 2019 shall be entitled to a tax holiday for first 7 years and a reduction of 50% for next 3 years.

Similarly, there is provision for exemption of custom duty on the import of plant, machinery, equipment and the spares thereof, except for 1% levied for record purpose. Value added tax payable on such imports were exempt till 2005/6 and the Finance Act, 2006/7 levied VAT on imports of these for plants of more than 3 MW capacity and on electricity transmitted at higher than 220 and 440 kV. In 2007/8 VAT on imports for more than 3 MW was continued to be levied. From 2008/9 onwards VAT has been exempted on import of plant, machinery, equipment for projects of all sizes.

9.         Power Purchase Agreement (PPA)
There is provision for signing of power purchase agreement (PPA) between the project developer and the utility. This will ensure requisite market for the power produced by a hydropower project. Additionally the PPA needs to be in place in order for a developer to be issued with implementation license by GoN.

However, electricity market has already developed such that hydropower projects are starting to be built as a merchant plant without the PPA in place. This allows such plants to maximize profit by generating power only when it fetches higher price. Power plants built as such are, however, subject to market and revenue risk.

10.       Foreign Investment Issues
The policy does address a number of issues related to foreign investment. Chief among them is repatriation which is guaranteed by Foreign Investment and Technology Transfer Act, 1992 and Electricity Act, 1992. Similarly, a foreign investor is entitled to specific number of visas in order to be able to bring in foreign experts for the implement of the project.

Foreign Investment & Technology Transfer Act, 1992 also affords choice of governing law to the foreign investors which is relevant for dispute settlement; either through arbitration or through judicial decision. Both arbitration and litigation at the court of law can be done under Nepal law or the law of a specific country of the investor’s choice. Arbitral award under foreign law is enforceable in Nepal.

However, there are problems associated with foreign governing law in settling disputes through judiciary. First of all the verdict of a foreign court is not enforceable in Nepal. Although, one of the merits of being able to choose foreign governing law is to have the chosen law used to adjudicate a case in the host country under the chosen law, Nepali courts will not adjudicate under foreign law. Further complication that might arise if a foreign law is chosen as governing law is that Nepali courts may not adjudicate when foreign law is chosen.

11.    Institutional mechanism.
The policy has provision for “one window” mechanism to facilitate project implementation. However, unfortunately, the experience shows that there are many doors behind the “one” window.

12.      Regulator
There is provision for the formation of “Electricity Tariff Fixation Commission” and its role is limited to fixation of tariff only and it cannot be called a regulator in its truest sense. Under the new policy promulgated in 2001, there is provision for the formation of “Nepal Electricity Regulatory Commission” but necessary enactment to enable GoN to form this institution is yet to be passed by the parliament.

Based on the presentation made on May 20, 2010 in Bankers' traning program in Pokhara

[1] Source:

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